UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark One)

(Mark One)
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 
   
 For the Quarterly Period Ended SeptemberJune 30, 20182019 
   
 OR 
   
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 

 

For the transition period from _________ to_________

 

Commission File Number 0-25923

 

Eagle Bancorp, Inc.

(Exact name of registrant as specified in its charter)

Maryland 52-2061461
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
   
7830 Old Georgetown Road, Third Floor, Bethesda, Maryland20814
(Address of principal executive offices)(Zip Code)

 

(301) 986-1800

(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

Securities Registered under Section 12(b) of the Act:

Title of Each ClassTrading Symbol(s)Name of Each Exchange on Which Registered
Common Stock, $0.01 par valueEGBNThe Nasdaq Stock Market, LLC

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒  No ☐

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definition of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company”) in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer☒Accelerated filer☐
Non-accelerated filer    ☐Smaller Reporting Company ☐
 Non-accelerated filer  ☐Smaller Reporting Company☐
Emerging Growth Company  ☐

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.Act 

Yes ☐ No ☒

 

As of OctoberJuly 31, 2018,2019, the registrant had 34,348,62434,542,796 shares of Common Stock outstanding.

 

 

 

 

EAGLE BANCORP, INC.

TABLE OF CONTENTS

 

PART I.FINANCIAL INFORMATION  
    
Item 1.Financial Statements (Unaudited) 3
 Consolidated Balance Sheets 3
 

Consolidated Statements of Operations

4
Consolidated Statements of Comprehensive Income

 4
5
 Consolidated Statements of Changes in Shareholders’ Equity 6
 Consolidated Statements of Cash Flows 78
 Notes to Consolidated Financial Statements 89
    
Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations 40
Item 3.Quantitative and Qualitative Disclosures About Market Risk6538
    
Item 4.3.ControlsQuantitative and ProceduresQualitative Disclosures About Market Risk 6562
    
PART II.Item 4.OTHER INFORMATIONControls and Procedures 62
    
Item 1.PART II.Legal ProceedingsOTHER INFORMATION 6663
    
Item 1A.1.Risk FactorsLegal Proceedings 6663
    
Item 2.1A.Unregistered Sales of Equity Securities and Use of ProceedsRisk Factors 6663
    
Item 3.2.Defaults Upon SeniorUnregistered Sales of Equity Securities and Use of Proceeds 6663
    
Item 4.3.Mine Safety DisclosuresDefaults Upon Senior Securities 6663
    
Item 5.4.Other InformationMine Safety Disclosures 6663
    
Item 6.5.ExhibitsOther Information 6663
    
Item 6.Exhibits63
Signatures 6966

 


Item 1 – Financial Statements (Unaudited)

 

EAGLE BANCORP, INC.

Consolidated Balance Sheets (Unaudited)

(dollars in thousands, except per share data)

 

Assets September 30, 2018  December 31, 2017  June 30, 2019  December 31, 2018 
Cash and due from banks $4,459  $7,445  $6,735  $6,773 
Federal funds sold  17,284   15,767   17,914   11,934 
Interest bearing deposits with banks and other short-term investments  162,734   167,261   171,985   303,157 
Investment securities available-for-sale, at fair value  722,674   589,268   745,343   784,139 
Federal Reserve and Federal Home Loan Bank stock  37,257   36,324   33,993   23,506 
Loans held for sale  18,728   25,096   37,506   19,254 
Loans  6,844,672   6,411,528   7,392,615   6,991,447 
Less allowance for credit losses  (68,189)  (64,758)  (72,086)  (69,944)
Loans, net  6,776,483   6,346,770   7,320,529   6,921,503 
Premises and equipment, net  17,457   20,991   15,176   16,851 
Operating lease right-of-use assets  28,214   — 
Deferred income taxes  35,196   28,770   30,220   33,027 
Bank owned life insurance  73,007   60,947   74,295   73,441 
Intangible assets, net  106,481   107,212   105,219   105,766 
Other real estate owned  1,394   1,394   1,394   1,394 
Other assets  84,701   71,784   81,480   88,392 
Total Assets $8,057,855  $7,479,029  $8,670,003  $8,389,137 
                
Liabilities and Shareholders’ Equity                
Liabilities                
Deposits:                
Noninterest bearing demand $2,057,886  $1,982,912  $1,873,902  $2,104,220 
Interest bearing transaction  459,455   420,417   862,553   593,107 
Savings and money market  2,573,258   2,621,146   2,712,143   2,949,559 
Time, $100,000 or more  758,152   515,682   801,469   801,957 
Other time  523,554   313,827   699,825   525,442 
Total deposits  6,372,305   5,853,984   6,949,892   6,974,285 
Customer repurchase agreements  36,446   76,561   31,669   30,413 
Other short-term borrowings  325,000   325,000   225,000   — 
Long-term borrowings  217,198   216,905   217,491   217,296 
Operating lease liabilities  31,659   — 
Other liabilities  45,255   56,141   29,710   58,202 
Total Liabilities  6,996,204   6,528,591   7,485,421   7,280,196 
                
Shareholders’ Equity                
Common stock, par value $.01 per share; shares authorized 100,000,000, shares issued and outstanding 34,308,473 and 34,185,163, respectively  341   340 
Common stock, par value $.01 per share; shares authorized 100,000,000, shares issued and outstanding 34,539,853 and 34,387,919, respectively  343   342 
Additional paid in capital  526,423   520,304   532,585   528,380 
Retained earnings  544,177   431,544   647,887   584,494 
Accumulated other comprehensive loss  (9,290)  (1,750)
Accumulated other comprehensive income (loss)  3,767   (4,275)
Total Shareholders’ Equity  1,061,651   950,438   1,184,582   1,108,941 
Total Liabilities and Shareholders’ Equity $8,057,855  $7,479,029  $8,670,003  $8,389,137 

 

See notes to consolidated financial statements.

 


EAGLE BANCORP, INC.

Consolidated Statements of Operations (Unaudited)

(dollars in thousands, except per share data)

 

 Three Months Ended September 30,  Nine Months Ended September 30,  Three Months Ended June 30,  Six Months Ended June 30, 
 2018  2017  2018  2017  2019  2018  2019  2018 
Interest Income                                
Interest and fees on loans $95,570  $78,176  $270,924  $226,543  $101,889  $90,924  $199,710  $175,354 
Interest and dividends on investment securities  4,875   3,194   12,525   8,854   5,238   4,058   10,836   7,650 
Interest on balances with other banks and short-term investments  1,897   991   4,152   2,084   1,105   1,274   2,771   2,255 
Interest on federal funds sold  18   9   104   27   47   40   96   86 
Total interest income  102,360   82,370   287,705   237,508   108,279   96,296   213,413   185,345 
Interest Expense                                
Interest on deposits  16,719   7,233   39,896   19,466   22,461   14,048   43,361   23,177 
Interest on customer repurchase agreements  54   58   166   136   75   62   173   112 
Interest on short-term borrowings  1,317   164   3,425   441   1,435   997   1,575   2,108 
Interest on long-term borrowings  2,979   2,979   8,937   8,937   2,979   2,979   5,958   5,958 
Total interest expense  21,069   10,434   52,424   28,980   26,950   18,086   51,067   31,355 
Net Interest Income  81,291   71,936   235,281   208,528   81,329   78,210   162,346   153,990 
Provision for Credit Losses  2,441   1,921   6,060   4,884   3,600   1,650   6,960   3,619 
Net Interest Income After Provision For Credit Losses  78,850   70,015   229,221   203,644   77,729   76,560   155,386   150,371 
                                
Noninterest Income                                
Service charges on deposits  1,814   1,626   5,188   4,641   1,606   1,760   3,300   3,374 
Gain on sale of loans  1,434   2,173   4,632   6,740   1,923   1,675   3,311   3,198 
Gain on sale of investment securities  —   11   68   542   563   26   1,475   68 
Increase in the cash surrender value of bank owned life insurance  373   369   1,073   1,108   429   356   854   700 
Other income  2,019   2,605   5,536   6,846   1,839   1,736   3,711   3,517 
Total noninterest income  5,640   6,784   16,497   19,877   6,360   5,553   12,651   10,857 
Noninterest Expense                                
Salaries and employee benefits  17,157   16,905   51,827   50,451   17,743   17,812   41,387   34,670 
Premises and equipment expenses  3,889   3,846   11,691   11,613   3,652   3,873   7,504   7,802 
Marketing and advertising  1,191   732   3,419   2,873   1,268   1,291   2,416   2,228 
Data processing  2,423   2,019   7,144   6,057   2,603   2,404   4,978   4,721 
Legal, accounting and professional fees  2,130   1,240   7,282   3,539   2,740   2,179   4,449   5,152 
FDIC insurance  933   929   2,559   2,063   1,126   951   2,242   1,626 
Other expenses  3,891   3,845   11,102   12,153   4,227   3,779   8,687   7,211 
Total noninterest expense  31,614   29,516   95,024   88,749   33,359   32,289   71,663   63,410 
Income Before Income Tax Expense  52,876   47,283   150,694   134,772   50,730   49,824   96,374   97,818 
Income Tax Expense  13,928   17,409   38,735   50,109   13,487   12,528   25,382   24,807 
Net Income $38,948  $29,874  $111,959  $84,663  $37,243  $37,296  $70,992  $73,011 
                                
Earnings Per Common Share                                
Basic $1.14  $0.87  $3.26  $2.48  $1.08  $1.09  $2.06  $2.13 
Diluted $1.13  $0.87  $3.25  $2.47  $1.08  $1.08  $2.05  $2.12 

See notes to consolidated financial statements.


EAGLE BANCORP, INC.

Consolidated Statements of Comprehensive Income (Unaudited)

(dollars in thousands)

  Three Months Ended June 30,  Six Months Ended June 30, 
  2019  2018  2019  2018 
Net Income $37,243  $37,296  $70,992  $73,011 
                 
Other comprehensive income (loss), net of tax:                
Unrealized gain (loss) on securities available for sale  5,925   (1,935)  11,979   (7,058)
Reclassification adjustment for net gains included in net income  (417)  (20)  (1,092)  (51)
Total unrealized gain (loss) on investment securities  5,508   (1,955)  10,887   (7,109)
Unrealized (loss) gain on derivatives  (513)  692   (1,665)  2,925 
Reclassification adjustment for amounts included in net income  (236)  64   (1,180)  (1)
Total unrealized (loss) gain on derivatives  (749)  756   (2,845)  2,924 
Other comprehensive income (loss)  4,759   (1,199)  8,042   (4,185)
Comprehensive Income $42,002  $36,097  $79,034  $68,826 

 

See notes to consolidated financial statements.

 


EAGLE BANCORP, INC.

Consolidated Statements of Comprehensive IncomeChanges in Shareholders’ Equity (Unaudited)

(dollars in thousands)thousands except share data)

 

  Three Months Ended September 30,  Nine Months Ended September 30, 
  2018  2017  2018  2017 
             
Net Income $38,948  $29,874  $111,959  $84,663 
                 
Other comprehensive income, net of tax:                
Unrealized (loss) gain on securities available for sale  (3,148)  15   (10,206)  1,243 
Reclassification adjustment for net gains included in net income  —   (7)  (51)  (340)
Total unrealized (loss) gain on investment securities  (3,148)  8   (10,257)  903 
Unrealized gain on derivatives  625   347   3,547   1,350 
Reclassification adjustment for amounts included in net income  (158)  (183)  (156)  (821)
Total unrealized gain on derivatives  467   164   3,391   529 
Other comprehensive (loss) income  (2,681)  172   (6,866)  1,432 
Comprehensive Income $36,267  $30,046  $105,093  $86,095 

  Common  Additional Paid  Retained  

Accumulated

Other Comprehensive

  Total Shareholders’ 
  Shares  Amount  in Capital  Earnings  Income (Loss)  Equity 
Balance April 1, 2019  34,537,193  $343  $530,894  $618,243  $(992) $1,148,488 
                         
Net Income  —   —   —   37,243   —   37,243 
Other comprehensive income, net of tax  —   —   —   —   4,759   4,759 
Stock-based compensation expense  —   —   1,471   —   —   1,471 
Issuance of common stock related to options exercised, net of shares withheld for payroll taxes  750   —   37   —   —   37 
Vesting of time based stock awards issued at date of grant, net of shares withheld for payroll taxes  (1,800)  —   —   —   —   — 
Issuance of common stock related to employee stock purchase plan  3,710   —   183   —   —   183 
Cash dividends declared ($0.22 per share)  —   —   —   (7,599)  —   (7,599)
Balance June 30, 2019  34,539,853  $343  $532,585  $647,887  $3,767  $1,184,582 
                         
Balance April 1, 2018  34,303,056  $341  $522,316  $467,933  $(5,410) $985,180 
                         
Net Income  —   —   —   37,296   —   37,296 
Other comprehensive loss, net of tax  —   —   —   —   (1,199)  (1,199)
Stock-based compensation expense  —   —   1,667   —   —   1,667 
Vesting of time based stock awards issued at date of grant, net of shares withheld for payroll taxes  (1,255)  —   —   —   —   — 
Issuance of common stock related to employee stock purchase plan  3,270   —   193   —   —   193 
Balance June 30, 2018  34,305,071  $341  $524,176  $505,229  $(6,609) $1,023,137 

 

See notes to consolidated financial statements.

 


EAGLE BANCORP, INC.

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

(dollars in thousands except share data)

  

         

Accumulated 

     Common Additional Paid Retained 

Accumulated

Other

Comprehensive

 Shareholders’ 
     Additional   

Other 

 Total  Shares Amount in Capital Earnings Income (Loss) Equity 
Balance January 1, 2019  34,387,919  $342  $528,380  $584,494  $(4,275) $1,108,941 
 Common  Paid in  Retained  Comprehensive  Shareholders’                         
 Shares  Amount  Capital  Earnings  Income (Loss)  Equity 
Net Income  —   —   —   70,992   —   70,992 
Other comprehensive income, net of tax  —   —   —   —   8,042   8,042 
Stock-based compensation expense  —   —   3,501   —   —   3,501 
Issuance of common stock related to options exercised, net of shares withheld for payroll taxes  26,784   —   332   —   —   332 
Vesting of time based stock awards issued at date of grant, net of shares withheld for payroll taxes  (12,744)  1   (1)  —   —   — 
Vesting of performance based stock awards, net of shares withheld for payroll taxes  17,655   —   —   —   —   — 
Time based stock awards granted  112,636   —   —   —   —   — 
Issuance of common stock related to employee stock purchase plan  7,603   —   373   —   —   373 
Cash dividends declared ($0.22 per share)  —   —   —   (7,599)  —   (7,599)
Balance June 30, 2019  34,539,853  $343  $532,585  $647,887  $3,767  $1,184,582 
                                     
Balance January 1, 2018  34,185,163  $340  $520,304  $431,544  $(1,750) $950,438   34,185,163  $340  $520,304  $431,544  $(1,750) $950,438 
                                                
Net Income  —   —   —   111,959   —   111,959   —   —   —   73,011   —   73,011 
Other comprehensive loss, net of tax  —   —   —   —   (6,866)  (6,866)  —   —   —   —   (4,185)  (4,185)
Stock-based compensation expense  —   —   5,174   —   —   5,174   —   —   3,143   —   —   3,143 
Issuance of common stock related to options exercised, net of shares withheld for payroll taxes  32,230   —   338   —   —   338   32,230   —   338   —   —   338 
Vesting of time based stock awards issued at date of grant, net of shares withheld for payroll taxes  (13,681)  1   (1)  —   —   —   (13,361)  1   (1)  —   —   — 
Time based stock awards granted  94,344   —   —   —   —   —   94,344   —   —   —   —   — 
Issuance of common stock related to employee stock purchase plan  10,417   —   608   —   —   608   6,695   —   392   —   —   392 
Reclassification of the income tax effects of the Tax Cuts and Jobs Act from AOCI (ASU 2018-02)  —   —   —   674   (674)  —   —   —   —   674   (674)  — 
Balance September 30, 2018  34,308,473  $341  $526,423  $544,177  $(9,290) $1,061,651 
                        
Balance January 1, 2017  34,023,850  $338  $513,531  $331,311  $(2,381) $842,799 
                        
Net Income  —   —   —   84,663   —   84,663 
Other comprehensive income, net of tax  —   —   —   —   1,432   1,432 
Stock-based compensation expense  —   —   4,198   1   —   4,199 
Issuance of common stock related to options exercised, net of shares withheld for payroll taxes  60,925   1   258   —   —   259 
Vesting of time based stock awards issued at date of grant, net of shares withheld for payroll taxes  (16,962)  1   (2)  —   —   (1)
Time based stock awards granted  91,097   —   —   —   —   — 
Issuance of common stock related to employee stock purchase plan  11,510   —   631   —   —   631 
Vesting of performance based stock awards, net of shares withheld for payroll taxes  3,589   —   —   —   —   — 
Balance September 30, 2017  34,174,009  $340  $518,616  $415,975  $(949) $933,982 
Balance June 30, 2018  34,305,071  $341  $524,176  $505,229  $(6,609) $1,023,137 

 

See notes to consolidated financial statements.


EAGLE BANCORP, INC.

Consolidated Statements of Cash Flows (Unaudited)

(dollars in thousands)

  

  Six Months Ended June 30, 
  2019  2018 
Cash Flows From Operating Activities:    ��   
Net Income $70,992  $73,011 
Adjustments to reconcile net income to net cash provided by operating activities:        
Provision for credit losses  6,960   3,619 
Depreciation and amortization  3,567   3,561 
Amortization of operating lease right-of-use assets  1,360   — 
Gains on sale of loans  (3,311)  (3,198)
Gains on sale of GNMA loans  (71)  — 
Securities premium amortization (discount accretion), net  2,519   2,169 
Origination of loans held for sale  (230,865)  (224,643)
Proceeds from sale of loans held for sale  215,995   222,444 
Net increase in cash surrender value of BOLI  (854)  (700)
Deferred income tax expense (benefit)  2,807   1,533 
Net gain on sale of investment securities  (1,475)  (68)
Stock-based compensation expense  3,501   3,143 
Net tax benefits from stock compensation  10   108 
Decrease (increase) in other assets  6,912   (12,644)
Decrease in other liabilities  (29,242)  (14,254)
Net cash provided by operating activities  48,805   54,081 
Cash Flows From Investing Activities:        
Purchases of available-for-sale investment securities  (63,572)  (150,528)
Proceeds from maturities of available-for-sale securities  67,223   42,144 
Proceeds from sale/call of available-for-sale securities  42,143   28,974 
Purchases of Federal Reserve and Federal Home Loan Bank stock  (76,150)  (42,179)
Proceeds from redemption of Federal Reserve and Federal Home Loan Bank stock  65,663   42,628 
Net increase in loans  (405,986)  (241,944)
Decrease (increase) in premises and equipment  1,675   (936)
Net cash used in investing activities  (369,004)  (321,841)
Cash Flows From Financing Activities:        
(Decrease) increase in deposits  (24,393)  414,774 
Increase (decrease) in customer repurchase agreements  1,256   (47,426)
Increase (decrease) in short-term borrowings  225,000   (25,000)
Proceeds from exercise of equity compensation plans  332   338 
Proceeds from employee stock purchase plan  373   392 
Cash dividends paid  (7,599)  — 
Net cash provided by financing activities  194,969   343,078 
Net (Decrease) Increase In Cash and Cash Equivalents  (125,230)  75,318 
Cash and Cash Equivalents at Beginning of Period  321,864   190,473 
Cash and Cash Equivalents at End of Period $196,634  $265,791 
Supplemental Cash Flows Information:        
Interest paid $51,735  $30,242 
Income taxes paid $31,850  $31,200 
Non-Cash Investing Activities        
Initial recognition of operating lease right-of-use assets $29,574  $— 
Initial recognition of operating lease liabilities $33,535  $— 

  

Nine Months Ended

September 30,

 
  2018  2017 
Cash Flows From Operating Activities:        
Net Income $111,959  $84,663 
Adjustments to reconcile net income to net cash provided by operating activities:        
Provision for credit losses  6,060   4,884 
Depreciation and amortization  5,292   5,161 
Gains on sale of loans  (4,632)  (6,740)
Securities premium amortization (discount accretion), net  3,297   2,799 
Origination of loans held for sale  (325,109)  (481,917)
Proceeds from sale of loans held for sale  336,109   514,306 
Net increase in cash surrender value of BOLI  (1,073)  (1,108)
(Increase) decrease in deferred income tax benefit  (6,426)  1,293 
Net loss on sale of other real estate owned  —   301 
Net gain on sale of investment securities  (68)  (542)
Stock-based compensation expense  5,174   4,199 
Net tax benefits from stock compensation  108   460 
Increase in other assets  (11,894)  (23,059)
(Decrease) increase in other liabilities  (10,886)  9,553 
Net cash provided by operating activities  107,911   114,253 
Cash Flows From Investing Activities:        
Purchases of available for sale investment securities  (246,501)  (144,554)
Proceeds from maturities of available for sale securities  68,901   55,732 
Proceeds from sale/call of available for sale securities  31,974   70,079 
Purchases of Federal Reserve and Federal Home Loan Bank stock  (47,811)  (27,665)
Proceeds from redemption of Federal Reserve and Federal Home Loan Bank stock  46,878   18,285 
Net increase in loans  (435,773)  (408,447)
Purchases of BOLI  (10,000)  — 
Proceeds from sale of other real estate owned  —   2,144 
Bank premises and equipment acquired  (727)  (2,459)
Net cash used in investing activities  (593,059)  (436,885)
Cash Flows From Financing Activities:        
Increase in deposits  518,321   197,838 
(Decrease) increase in customer repurchase agreements  (40,115)  4,693 
Increase in short-term borrowings  —   200,000 
Proceeds from exercise of equity compensation plans  338   257 
Proceeds from employee stock purchase plan  608   631 
Net cash provided by financing activities  479,152   403,419 
Net (Decrease) Increase In Cash and Cash Equivalents  (5,996)  80,787 
Cash and Cash Equivalents at Beginning of Period  190,473   368,163 
Cash and Cash Equivalents at End of Period $184,477  $448,950 
Supplemental Cash Flows Information:        
Interest paid $53,405  $31,257 
Income taxes paid $39,900  $52,800 
Non-Cash Investing Activities        
Transfers from loans to other real estate owned $—  $1,145 

 

See notes to consolidated financial statements.

 


EAGLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The Consolidated Financial Statements include the accounts of Eagle Bancorp, Inc. and its subsidiaries (the “Company”),. Active subsidiaries include: EagleBank (the “Bank”), Eagle Commercial Ventures, LLC (“ECV”), Eagle Insurance Services, LLC, and Bethesda Leasing, LLC, and Landroval Municipal Finance, Inc., with all significant intercompany transactions eliminated.

 

The Consolidated Financial Statements of the Company included herein are unaudited. The Consolidated Financial Statements reflect all adjustments, consisting of normal recurring accruals that in the opinion of management, are necessary to present fairly the results for the periods presented. The amounts as of and for the year ended December 31, 20172018 were derived from audited Consolidated Financial Statements. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The Company applies the accounting policies contained in Note 1 to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.2018. There have been no significant changes to the Company’s Accounting Policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.2018 except as indicated in the “Accounting Standards Adopted in 2019” section below. The Company believes that the disclosures are adequate to make the information presented not misleading. Certain reclassifications have been made to amounts previously reported to conform to the current period presentation.

 

These statements should be read in conjunction with the audited Consolidated Financial Statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.2018. Operating results for the three and ninesix months ended SeptemberJune 30, 20182019 are not necessarily indicative of the results of operations to be expected for the remainder of the year, or for any other period.

 

Nature of Operations

 

The Company, through the Bank, conducts a full service community banking business, primarily in Northern Virginia, Suburban Maryland, and Washington, D.C. The primary financial services offered by the Bank include real estate, commercial and consumer lending, as well as traditional deposit and repurchase agreement products. The Bank is also active in the origination and sale of residential mortgage loans, the origination of small business loans, and the origination, securitization and sale of multifamily Federal Housing Administration (“FHA”) loans. The guaranteed portion of small business loans, guaranteed by the Small Business Administration (“SBA”), is typically sold to third party investors in a transaction apart from the loan’s origination. The Bank offers its products and services through twenty banking offices, five lending centers and various electronic capabilities, including remote deposit services and mobile banking services. Eagle Insurance Services, LLC, a subsidiary of the Bank, offers access to insurance products and services through a referral program with a third party insurance broker. Eagle Commercial Ventures, LLC,Landroval Municipal Finance, Inc., a direct subsidiary of the Company, has provided subordinated financing forBank, focuses on lending to municipalities by buying debt on the acquisition, development and construction of real estate projects; these transactions involve higher levels of risk, together with commensurate higher returns.public market as well as direct purchase issuance.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results may differ from those estimates and such differences could be material to the financial statements.


New Authoritative Accounting Guidance

 

Accounting Standards Adopted in 20182019

ASU 2014-09,“Revenue from Contracts with Customers (Topic 606).” The amendments in ASU 2014-09 supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. The general principle of the amendments require an entity to recognize revenue upon the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance sets forth a five step approach to be utilized for revenue recognition. The Company completed its overall assessment of revenue streams and review of related contracts potentially affected by the ASU, including deposit related fees, interchange fees, and merchant income. Based on this assessment, the Company concluded that ASU 2014-09 did not materially change the method in which the Company currently recognizes revenue for these revenue streams. The Company also completed its evaluation of certain costs related to these revenue streams to determine whether such costs should be presented as expenses or contra-revenue (i.e., gross vs. net). Based on its evaluation, the Company did not identify revenue streams within the scope of ASC 606 that required a material change in their presentation under the gross vs. net requirement of ASC 606. The Company adopted ASU 2014-09 and its related amendments on its required effective date of January 1, 2018 utilizing the modified retrospective approach. Since there was no net income impact upon adoption of the new guidance, a cumulative effect adjustment to opening retained earnings was not deemed necessary. Consistent with the modified retrospective approach, the Company did not adjust prior period amounts.

The majority of our revenue-generating transactions are not subject to ASC 606, including revenue generated from financial instruments, such as our loans, letters of credit, derivatives and investment securities, as well as revenue related to our mortgage servicing activities, as these activities are subject to other GAAP discussed elsewhere within our disclosures. Substantially all of the Company’s revenue is generated from contracts with customers. Descriptions of our revenue-generating activities that are within the scope of ASC 606, which are presented in our income statements as components of noninterest income are as follows:

●Service charges on deposit accounts - these represent general service fees for monthly account maintenance and activity- or transaction-based fees and consist of transaction-based revenue, time-based revenue (service period), item-based revenue or some other individual attribute-based revenue. Revenue is recognized when our performance obligation is completed which is generally monthly for account maintenance services or when a transaction has been completed (such as a wire transfer). Payment for such performance obligations are generally received at the time the performance obligations are satisfied.
●Other Fees – generally, the Company receives compensation when a customer that it refers opens an account with certain third-parties. This category includes credit card, investment advisory, and interchange fees. The timing and amount of revenue recognition is not materially impacted by the new standard.
●Sale of OREO – ASU 2014-09 prescribes derecognition requirements for the sale of OREO that are less prescriptive than existing derecognition requirements. Previously, the Company was required to assess 1) the adequacy of a buyer’s initial and continuing investments and 2) the seller’s continuing involvement with the property. ASU 2014-09 requires an entity to assess whether it is “probable” that it will collect the consideration to which it will be entitled in exchange for transferring the asset to the customer. The new requirements could result in earlier revenue recognition; however, such sales are infrequent and the impact of this change is not expected to be material to our financial statements.

A contract asset balance occurs when an entity performs a service for a customer before the customer pays consideration (resulting in a contract receivable) or before payment is due (resulting in a contract asset). A contract liability balance is an entity’s obligation to transfer a service to a customer for which the entity has already received payment (or payment is due) from the customer. The Company’s noninterest revenue streams are largely based on transactional activity, or standard month-end revenue accruals based on fee schedules. Consideration is often received immediately or shortly after the Company satisfies its performance obligation and revenue is recognized. The Company does not typically enter into long-term revenue contracts with customers, and therefore, does not have contract balances material to our financial statements. As of September 30, 2018 and December 31, 2017, the Company did not have any significant contract balances.

In connection with the adoption of Topic 606, an entity is required to capitalize, and subsequently amortize into expense, certain incremental costs of obtaining a contract with a customer if these costs are expected to be recovered. The incremental costs of obtaining a contract are those costs that an entity incurs to obtain a contract with a customer that it would not have incurred if the contract had not been obtained (for example, sales commission). The Company utilizes the practical expedient which allows entities to immediately expense contract acquisition costs when the asset that would have resulted from capitalizing these costs would have been amortized in one year or less. Upon adoption of Topic 606, the Company did not capitalize any contract acquisition cost.


ASU 2016-01, “Financial Instruments—(Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities.” ASU 2016-01 addresses certain aspects of recognition, measurement, presentation, and disclosure of financial instruments by making targeted improvements to GAAP as follows: (1) require equity investments (except those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income. However, an entity may choose to measure equity investments that do not have readily determinable fair values at cost minus impairment, if any, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer; (2) simplify the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment. When a qualitative assessment indicates that impairment exists, an entity is required to measure the investment at fair value; (3) eliminate the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities; (4) eliminate the requirement for public business entities to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (5) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (6) require an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (7) require separate presentation of financial assets and financial liabilities by measurement category and form of financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements; and (8) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale securities in combination with the entity’s other deferred tax assets. ASU No. 2016-01 was effective for us effective January 1, 2018 and did not have a material impact on our Consolidated Financial Statements. Refer to Note 11 for the valuation of the loan portfolio using the exit price notion.

ASU 2016-15“Statement of Cash Flows (Topic 230)” is intended to reduce the diversity in practice around how certain transactions are classified within the statement of cash flows. ASU 2016-15 became effective for us on January 1, 2018 and did not have a significant impact on our financial statements.

ASU 2017-12,“Derivatives and Hedging (Topic 815) - Targeted Improvements to Accounting for Hedging Activities.”ASU 2017-12 amends the hedge accounting recognition and presentation requirements in ASC 815 to improve the transparency and understandability of information conveyed to financial statement users about an entity’s risk management activities to better align the entity’s financial reporting for hedging relationships with those risk management activities and to reduce the complexity of and simplify the application of hedge accounting. The Company early adopted ASU 2017-12 effective January 1, 2018. The new standard did not have a material impact to our Consolidated Financial Statements.

ASU 2018-02, “Income Statement - Reporting Comprehensive Income (Topic 220)- Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income.” ASU 2018-02 allows a reclassification from accumulated other comprehensive income (loss) (“AOCI”) to retained earnings for the tax effects caused by the revaluation of deferred taxes resulting from the newly enacted corporate tax rate in the Tax Cuts and Jobs Act of 2017. The ASU is effective in years beginning after December 15, 2018, but permits early adoption in a period for which financial statements have not yet been issued. We elected to early adopt the ASU as of January 1, 2018. The adoption of the guidance resulted in a $674 thousand cumulative-effect adjustment, done on a portfolio basis, to reclassify the income tax effects resulting from tax reform from AOCI to retained earnings. The adjustment increased retained earnings and decreased AOCI in the first quarter of 2018.

Accounting Standards Pending Adoption

 

ASU 2016-02,“Leases “Leases (Topic 842).” Under the new guidance, ASU 2016-02 has, among other things, required lessees will be required to recognize the following for all leases (with the exception of short-term leases): (1) a lease liability, which is the present value of a lessee’s obligation to make lease payments, measured on a discounted basis; and (2) a right-of-use (“ROU”) asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. LessorASU 2016-02 did not significantly change lease accounting under the new guidance remains largely unchanged as it is substantially equivalentrequirements applicable to existing guidance for sales-type leases, direct financing leases, and operating leases. Leveraged leases have been eliminated, although lessors can continue to account for existing leveraged leases using the current accounting guidance. Other limitedlessors; however, certain changes were made to align, where necessary, lessor accounting with the lessee accounting model and the new revenue recognition standard. All entities will classify leases to determine how to recognize lease-related revenue and expense. Quantitative and qualitative disclosures will be required by lessees and lessors to meet the objective of enabling users of financial statements to assess the amount, timing, and uncertainty of cash flows arisingASC Topic 606, “Revenue from leases. The intention is to require enough information to supplement the amounts recorded in the financial statements so that users can understand more about the nature of an entity’s leasing activities.Contracts with Customers.” ASU 2016-02 isbecame effective for interimus on January 1, 2019 and annual reporting periods beginning after December 15, 2018; early adoption is permitted. All entities areinitially required to usetransition using a modified retrospective approach for leases that existexisting at, or are entered into after, the beginning of the earliest comparative period presented in the financial statements. They haveIn July 2018, the optionFASB issued ASU 2018-11, “Leases (Topic 842) – Targeted Improvements,” which, among other things, provides an additional transition method that allows entities to usenot apply the guidance in ASU 2016-02 in the comparative periods presented in the financial statements and instead recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. In December 2018, the FASB also issued ASU 2018-20, “Leases (Topic 842) - Narrow-Scope Improvements for Lessors,” which provides for certain relief; full retrospective application is prohibited. The Company is currently evaluating the provisionspolicy elections and changes lessor accounting for sales and similar taxes and certain lessor costs. Upon adoption of ASU 2016-02, researching softwareASU 2018-11 and ASU 2018-20 on January 1, 2019, we recognized ROU assets of $29.6 million and related lease liabilities of $33.5 million which reduced the March 31, 2019 total risk based capital ratio by six basis points. We elected to aid inapply certain practical expedients provided under ASU 2016-02 whereby we did not reassess (i) whether any expired or existing contracts were or contained leases, (ii) the lease classification for any expired or existing leases and (iii) initial direct costs for any existing leases. We also elected to not apply the recognition requirements of ASU 2016-02 to any short-term leases (as defined by related accounting guidance). We utilized the modified-retrospective transition to the new leasing guidance, and will be closely monitoring developments and additional guidance to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements.approach prescribed by ASU 2018-11.


Accounting Standards Pending Adoption

ASU 2016-13,“Measurement of Credit Losses on Financial Instruments (Topic 326).” This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. In issuing the standard, the FASB is responding to criticism that today’s guidance for determining the allowance for credit losses delays recognition of expected future credit losses. The standard will replace today’s “incurred loss” approach with an “expected loss” model. The new model, referred to as the current expected credit loss (“CECL”) model, will apply to: (1) financial assets subject to credit losses and measured at amortized cost, and (2) certain off-balance sheet credit exposures. This includes, but is not limited to, loans, leases, held-to-maturity securities, loan commitments, and financial guarantees. The CECL model does not apply to available-for-sale (“AFS”) debt securities. For AFS debt securities with unrealized losses, entities will measure credit losses in a manner similar to what they do today, except that the losses will be recognized as allowances rather than reductions in the amortized cost of the securities. The ASU also simplifies the accounting model for purchased credit-impaired debt securities and loans. ASU 2016-13 also expands the disclosure requirements regarding an entity’s assumptions, models, and methods for estimating the allowance for loan and lease losses. In addition, entities will need to disclose the amortized cost balance for each class of financial asset by credit quality indicator, disaggregated by the year of origination. ASU No. 2016-13 is effective for the Company beginning on January 1, 2020; early adoption is permitted for us beginning on January 1, 2019.2020. Entities will apply any changes resulting from the application of the new standard’s provisions as a cumulative-effect adjustment to retained earnings as of the beginning of the first reporting period in which the guidance is effective (i.e., modified retrospective approach). We have substantially concluded our data gap analysis and have contracted with a third partyparties to develop and evaluate a model to comply with CECL requirements. We have entered our data into the model and are working on the qualitative and forecasting aspects of the methodology. We have established a steering committee with representation from various departments across the enterprise. The committee has agreed to a project plan and has regular meetings to ensure adherence to our implementation timeline. The Company is currently evaluating the provisions of ASU No. 2016-13 to determine the potential impact the new standard will have on the Company’sCompany's Consolidated Financial Statements.

ASU 2017-04, “Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment.” ASU 2017-04 eliminates Step 2 from the goodwill impairment test which required entities to compute the implied fair value of goodwill. Under ASU 2017-04, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity should recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. ASU 2017-04 will be effective for the Company on January 1, 2020, with early adoption permitted for interim or annual impairment tests beginning in 2017, and is not expected to have a significant impact on our consolidated financial statements. We expect to implement ASU 2017-04 prior to 2018 year-end.

 

Note 2. Cash and Due from Banks

 

Regulation D of the Federal Reserve Act requires that banks maintain noninterest reserve balances with the Federal Reserve Bank based principally on the type and amount of their deposits. During 2018,2019, the Bank maintained balances at the Federal Reserve sufficient to meet reserve requirements, as well as significant excess reserves, on which interest is paid.

 

Additionally, the Bank maintains interest bearing balances with the Federal Home Loan Bank of Atlanta and noninterest bearing balances with domestic correspondent banks as compensation for services they provide to the Bank.


Note 3. Investment Securities Available-for-Sale

 

Amortized cost and estimated fair value of securities available-for-sale are summarized as follows:

 

September 30, 2018
(dollars in thousands)		 Amortized
Cost		  Gross
Unrealized
Gains		  Gross
Unrealized
Losses		  Estimated
Fair
Value		 
U. S. agency securities $236,853  $—  $6,528  $230,325 
Residential mortgage backed securities  448,335   140   12,126   436,349 
Municipal bonds  48,203   391   858   47,736 
Corporate bonds  8,004   61   19   8,046 
Other equity investments  218   —   —   218 
  $741,613  $592  $19,531  $722,674 

     Gross  Gross  Estimated 
June 30, 2019 Amortized  Unrealized  Unrealized  Fair 
(dollars in thousands) Cost  Gains  Losses  Value 
U. S. agency securities $225,389  $940 $659  $225,670 
Residential mortgage backed securities  440,243   5,186   1,884   443,545 
Municipal bonds  67,835   1,503   —   69,338 
Corporate bonds  6,502   70   —   6,572 
Other equity investments  218   —   —   218 
  $740,187  $7,699  $2,543  $745,343 

 

December 31, 2017
(dollars in thousands)		 Amortized
Cost		  Gross
Unrealized
Gains		  Gross
Unrealized
Losses		  Estimated
Fair
Value		 
   Gross Gross Estimated 
December 31, 2018 Amortized Unrealized Unrealized Fair 
(dollars in thousands) Cost  Gains  Losses  Value 
U. S. agency securities $198,115  $283  $2,414  $195,984  $260,150  $228 $4,033  $256,345 
Residential mortgage backed securities  322,067   187   4,418   317,836   477,949   1,575   7,293   472,231 
Municipal bonds  60,976   1,295   214   62,057   45,814   439   484   45,769 
Corporate bonds  13,010   163   —   13,173   9,503   79   6   9,576 
Other equity investments  218   —   —   218   218   —   —   218 
 $594,386  $1,928  $7,046  $589,268  $793,634  $2,321  $11,816  $784,139 

 

In addition, at SeptemberJune 30, 20182019 and December 31, 20172018 the Company held $37.3$34.0 million and $36.3$23.5 million, respectively, in equity securities in a combination of Federal Reserve Bank (“FRB”) and Federal Home Loan Bank (“FHLB”) stocks, which are required to be held for regulatory purposes and which are not marketable, and therefore are carried at cost.

 

Gross unrealized losses and fair value by length of time that the individual available-for-sale securities have been in a continuous unrealized loss position are as follows:

 

     Less than
12 Months		  12 Months
or Greater		  Total 
September 30, 2018
(dollars in thousands)		 Number of
Securities		  Estimated
Fair
Value		  Unrealized
Losses		  Estimated
Fair
Value		  Unrealized
Losses		  Estimated
Fair
Value		  Unrealized
Losses		 
U. S. agency securities  61  $111,702  $1,909  $115,678  $4,619  $227,380  $6,528 
Residential mortgage backed securities  184   237,720   3,938   190,668   8,188   428,388   12,126 
Municipal bonds  16   16,388   352   10,440   506   26,828   858 
Corporate bonds  2   2,981   19   —   —   2,981   19 
   263  $368,791  $6,218  $316,786  $13,313  $685,577  $19,531 

     Less than
12 Months		  12 Months
or Greater		  Total 
December 31, 2017
(dollars in thousands)		 Number of
Securities		  Estimated
Fair
Value		  Unrealized
Losses		  Estimated
Fair
Value		  Unrealized
Losses		  Estimated
Fair
Value		  Unrealized
Losses		 
U. S. agency securities  38  $102,264  $1,073  $55,093  $1,341  $157,357  $2,414 
Residential mortgage backed securities  137   152,350   1,306   147,953   3,112   300,303   4,418 
Municipal bonds  8   17,446   214   —   —   17,446   214 
   183  $272,060  $2,593  $203,046  $4,453  $475,106  $7,046 

     Less than  12 Months    
     12 Months  or Greater  Total 
     Estimated     Estimated     Estimated    
June 30, 2019 Number of  Fair  Unrealized  Fair  Unrealized  Fair  Unrealized 
(dollars in thousands) Securities  Value  Losses  Value  Losses  Value  Losses 
U. S. agency securities  39  $26,149  $50  $99,252  $609  $125,401  $659 
Residential mortgage backed securities  103   4,234   13   174,316   1,871   178,550   1,884 
Municipal bonds  2   1,500   —   —   —   1,500   — 
   144  $31,883  $63  $273,568  $2,480  $305,451  $2,543 

                      
     Less than  12 Months       
     12 Months  or Greater  Total 
     Estimated     Estimated     Estimated    
December 31, 2018 Number of  Fair  Unrealized  Fair  Unrealized  Fair  Unrealized 
(dollars in thousands) Securities  Value  Losses  Value  Losses  Value  Losses 
U. S. agency securities  58  $72,679  $533  $144,636  $3,500  $217,315  $4,033 
Residential mortgage backed securities  151   61,199   527   225,995   6,766   287,194   7,293 
Municipal bonds  11   4,299   50   17,041   434   21,340   484 
Corporate bonds  1   1,494   6   —   —   1,494   6 
   221  $139,671  $1,116  $387,672  $10,700  $527,343  $11,816 

  

The unrealized losses that exist are generally the result of changes in market interest rates and interest spread relationships since original purchases. The weighted average duration of debt securities, which comprise 99.9% of total investment securities, is relatively short at 3.93.0 years. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. The Company does not believe that the investment securities that were in an unrealized loss position as of SeptemberJune 30, 20182019 represent an other-than-temporary impairment. The Company does not intend to sell the investments and it is more likely than not that the Company will not have to sell the securities before recovery of its amortized cost basis, which may be at maturity.


The amortized cost and estimated fair value of investments available-for-sale at SeptemberJune 30, 20182019 and December 31, 20172018 by contractual maturity are shown in the table below. Expected maturities for residential mortgage backed securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

  September 30, 2018  December 31, 2017 
(dollars in thousands) Amortized
Cost		  Estimated
Fair Value		  Amortized
Cost		  Estimated
Fair Value		 
U. S. agency securities maturing:                
One year or less $119,017  $114,692  $109,893  $108,198 
After one year through five years  104,464   102,953   74,106   73,916 
Five years through ten years  13,372   12,680   14,116   13,870 
Residential mortgage backed securities  448,335   436,349   322,067   317,836 
Municipal bonds maturing:                
One year or less  9,882   9,969   5,068   5,171 
After one year through five years  15,579   15,541   19,405   19,879 
Five years through ten years  21,675   21,094   35,432   35,846 
After ten years  1,067   1,132   1,071   1,161 
Corporate bonds maturing:                
After one year through five years  6,504   6,546   11,510   11,673 
After ten years  1,500   1,500   1,500   1,500 
Other equity investments  218   218   218   218 
  $741,613  $722,674  $594,386  $589,268 

  June 30, 2019  December 31, 2018 
  Amortized  Estimated  Amortized  Estimated 
(dollars in thousands) Cost  Fair Value  Cost  Fair Value 
U. S. agency securities maturing:                
One year or less $114,260  $114,564  $128,148  $125,545 
After one year through five years  103,105   103,042   119,856   118,883 
Five years through ten years  8,024   8,064   12,146   11,917 
Residential mortgage backed securities  440,243   443,545   477,949   472,231 
Municipal bonds maturing:                
One year or less  6,947   6,977   8,097   8,167 
After one year through five years  13,426   13,694   15,025   15,081 
Five years through ten years  46,399   47,468   21,626   21,385 
After ten years  1,063   1,199   1,066   1,136 
Corporate bonds maturing:                
After one year through five years  5,002   5,072   8,003   8,076 
After ten years  1,500   1,500   1,500   1,500 
Other equity investments  218   218   218   218 
  $740,187  $745,343  $793,634  $784,139 

 

For the ninesix months ended SeptemberJune 30, 2019, gross realized gains on sales of investments securities were $1.5 million, primarily due to $829 thousand of noninterest income recognized during March 2019 on interest rate swap terminations, and there were no gross realized losses on sales of investment securities. For the six months ended June 30, 2018, gross realized gains on sales of investments securities were $93 thousand and gross realized losses on sales of investment securities were $25 thousand. For the nine months ended September 30, 2017, gross realized gains on sales of investments securities were $795 thousand and gross realized losses on sales of investment securities were $254 thousand. 

 

Proceeds from sales and calls of investment securities for the ninethree months ended SeptemberJune 30, 20182019 were $32.0$42.1 million compared to $70.1$29.0 million for the same period in 2017.2018.

 

The carrying value of securities pledged as collateral for certain government deposits, securities sold under agreements to repurchase, and certain lines of credit with correspondent banks at SeptemberJune 30, 20182019 and December 31, 20172018 was $486.9$460.6 million and $465.4$528.2 million, respectively, which is well in excess of required amounts in order to operationally provide significant reserve amounts for new business. As of SeptemberJune 30, 20182019 and December 31, 2017,2018, there were no holdings of securities of any one issuer, other than the U.S. Government and U.S. agency securities, which exceeded ten percent of shareholders’ equity.

 

Note 4. Mortgage Banking Derivative

 

As part of its mortgage banking activities, the Bank enters into interest rate lock commitments, which are commitments to originate loans where the interest rate on the loan is determined prior to funding and the customers have locked into that interest rate. The Bank then locks in the loan and interest rate with an investor and commits to deliver the loan if settlement occurs (“best efforts”) or commits to deliver the locked loan in a binding (“mandatory”) delivery program with an investor. Certain loans under interest rate lock commitments are covered under forward sales contracts of mortgage backed securities (“MBS”). Forward sales contracts of MBS are recorded at fair value with changes in fair value recorded in noninterest income. Interest rate lock commitments and commitments to deliver loans to investors are considered derivatives. The market value of interest rate lock commitments and best efforts contracts are not readily ascertainable with precision because they are not actively traded in stand-alone markets. The Bank determines the fair value of interest rate lock commitments and delivery contracts by measuring the fair value of the underlying asset, which is impacted by current interest rates, taking into consideration the probability that the interest rate lock commitments will close or will be funded.

 


Certain additional risks arise from these forward delivery contracts in that the counterparties to the contracts may not be able to meet the terms of the contracts. The Bank does not expect any counterparty to any MBS to fail to meet its obligation. Additional risks inherent in mandatory delivery programs include the risk that, if the Bank does not close the loans subject to interest rate risk lock commitments, it will still be obligated to deliver MBS to the counterparty under the forward sales agreement. Should this be required, the Bank could incur significant costs in acquiring replacement loans or MBS and such costs could have an adverse effect on mortgage banking operations.


The fair value of the mortgage banking derivatives is recorded as a freestanding asset or liability with the change in value being recognized in current earnings during the period of change.

 

At SeptemberJune 30, 20182019 the Bank had mortgage banking derivative financial instruments with a notional value of $39.9$124.5 million related to its forward contracts as compared to $37.1$49.6 million at December 31, 2017.2018. The fair value of these mortgage banking derivative instruments at SeptemberJune 30, 20182019 was $80$387 thousand included in other assets and $28$309 thousand included in other liabilities as compared to $43$229 thousand included in other assets and $10$269 thousand included in other liabilities at December 31, 2017.2018.

 

Included in other noninterest income for the three and ninesix months ended SeptemberJune 30, 20182019 was a net gain of $10$84 thousand and a net loss of $42gain $219 thousand, respectively, relating to mortgage banking derivative instruments as compared to a net gain of $71$55 thousand and a net gainloss of $335$31 thousand respectively, as of SeptemberJune 30, 2017.2018. The amount included in other noninterest income for the three and ninesix months ended SeptemberJune 30, 20182019 pertaining to its mortgage banking hedging activities was a net realized gainloss of $56$94 thousand and noa net realized gain,loss of $49 thousand, respectively, as compared to a net realized loss of $14$147 thousand and a net realized loss of $912$56 thousand respectively, as of SeptemberJune 30, 2017.2018.

 

Note 5. Loans and Allowance for Credit Losses

 

The Bank makes loans to customers primarily in the Washington, D.C. metropolitan area and surrounding communities. A substantial portion of the Bank’s loan portfolio consists of loans to businesses secured by real estate and other business assets.

 

Loans, net of unamortized net deferred fees, at SeptemberJune 30, 20182019 and December 31, 20172018 are summarized by type as follows:

 

  September 30, 2018  December 31, 2017 
(dollars in thousands) Amount  %  Amount  % 
Commercial $1,493,577   22% $1,375,939   21%
Income producing - commercial real estate  3,189,910   46%  3,047,094   48%
Owner occupied - commercial real estate  863,162   13%  755,444   12%
Real estate mortgage - residential  104,864   2%  104,357   2%
Construction - commercial and residential  1,047,591   15%  973,141   15%
Construction - C&I (owner occupied)  56,572   1%  58,691   1%
Home equity  86,525   1%  93,264   1%
Other consumer  2,471   —   3,598   — 
Total loans  6,844,672   100%  6,411,528   100%
Less: allowance for credit losses  (68,189)      (64,758)    
Net loans $6,776,483      $6,346,770     

  June 30, 2019  December 31, 2018 
(dollars in thousands) Amount  %  Amount  % 
Commercial $1,475,201   20% $1,553,112   22%
Income producing - commercial real estate  3,666,815   50%  3,256,900   46%
Owner occupied - commercial real estate  970,850   13%  887,814   13%
Real estate mortgage - residential  105,191   1%  106,418   2%
Construction - commercial and residential  1,012,789   14%  1,039,815   15%
Construction - C&I (owner occupied)  76,324   1%  57,797   1%
Home equity  83,447   1%  86,603   1%
Other consumer  1,998   —   2,988   — 
Total loans  7,392,615   100%  6,991,447   100%
Less: allowance for credit losses  (72,086)      (69,944)    
Net loans $7,320,529      $6,921,503     

 

Unamortized net deferred fees amounted to $24.5$25.2 million and $23.9$26.5 million at SeptemberJune 30, 20182019 and December 31, 2017,2018, respectively.

 

As of SeptemberJune 30, 20182019 and December 31, 2017,2018, the Bank serviced $207.3$101.8 million and $195.3$111.1 million, respectively, of multifamily FHA loans, SBA loans and other loan participations which are not reflected as loan balances on the Consolidated Balance Sheets.


Loan Origination / Risk Management

 

The Company’s goal is to mitigate risks in the event of unforeseen threats to the loan portfolio as a result of economic downturn or other negative influences. Plans for mitigating inherent risks in managing loan assets include: carefully enforcing loan policies and procedures, evaluating each borrower’s business plan during the underwriting process and throughout the loan term, identifying and monitoring primary and alternative sources for loan repayment, and obtaining collateral to mitigate economic loss in the event of liquidation. Specific loan reserves are established based upon credit and/or collateral risks on an individual loan basis. A risk rating system is employed to proactively estimate loss exposure and provide a measuring system for setting general and specific reserve allocations.

 

The composition of the Company’s loan portfolio is heavily weighted toward commercial real estate, both owner occupied and income producing real estate. At SeptemberJune 30, 2018,2019, owner occupied - commercial real estate and construction - C&I (owner occupied) represent approximately 14% of the loan portfolio. At SeptemberJune 30, 2018,2019, non-owner occupied commercial real estate and real estate construction represented approximately 61%64% of the loan portfolio. The combined owner occupied and commercial real estate loans represent approximately 75%78% of the loan portfolio. Real estate also serves as collateral for loans made for other purposes, resulting in 84% of all loans being secured by real estate. These loans are underwritten to mitigate lending risks typical of this type of loan such as declines in real estate values, changes in borrower cash flow and general economic conditions. The Bank typically requires a maximum loan to value of 80% and minimum cash flow debt service coverage of 1.15 to 1.0. Personal guarantees may be required, but may be limited. In making real estate commercial mortgage loans, the Bank generally requires that interest rates adjust not less frequently than five years.

  

The Company is also an active traditional commercial lender providing loans for a variety of purposes, including working capital, equipment and account receivable financing. This loan category represents approximately 22%20% of the loan portfolio at SeptemberJune 30, 20182019 and was generally variable or adjustable rate. Commercial loans meet reasonable underwriting standards, including appropriate collateral and cash flow necessary to support debt service. Personal guarantees are generally required, but may be limited. SBA loans represent approximately 2% of the commercial loan category. In originating SBA loans, the Company assumes the risk of non-payment on the unguaranteed portion of the credit.credit as well as potential repairs to the SBA guarantees. The Company generally sells the guaranteed portion of the loan generating noninterest income from the gains on sale, as well as servicing income on the portion participated. SBA loans are subject to the same cash flow analyses as other commercial loans. SBA loans are subject to a maximum loan size established by the SBA as well as internal loan size guidelines.

 

Approximately 1% of the loan portfolio at SeptemberJune 30, 20182019 consists of home equity loans and lines of credit and other consumer loans. These credits, while making up a small portion of the loan portfolio, demand the same emphasis on underwriting and credit evaluation as other types of loans advanced by the Bank.

 

Approximately 2%1% of the loan portfolio consists of residential mortgage loans. The repricing duration of these loans was 2120 months. These credits represent first liens on residential property loans originated by the Bank. While the Bank’s general practice is to originate and sell (servicing released) loans made by its Residential Lending department, from time to time certain loan characteristics do not meet the requirements of third party investors and these loans are instead maintained in the Bank’s portfolio until they are resold to another investor at a later date or mature.

 

Loans are secured primarily by duly recorded first deeds of trust or mortgages. In some cases, the Bank may accept a recorded junior trust position. In general, borrowers will have a proven ability to build, lease, manage and/or sell a commercial or residential project and demonstrate satisfactory financial condition. Additionally, an equity contribution toward the project is customarily required.

 

Construction loans require that the financial condition and experience of the general contractor and major subcontractors be satisfactory to the Bank. Guaranteed, fixed price contracts are required whenever appropriate, along with payment and performance bonds or completion bonds for larger scale projects.

 

Loans intended for residential land acquisition, lot development and construction are made on the premise that the land: 1) is or will be developed for building sites for residential structures, and; 2) will ultimately be utilized for construction or improvement of residential zoned real properties, including the creation of housing. Residential development and construction loans will finance projects such as single family subdivisions, planned unit developments, townhouses, and condominiums. Residential land acquisition, development and construction loans generally are underwritten with a maximum term of 36 months, including extensions approved at origination.


Commercial land acquisition and construction loans are secured by real property where loan funds will be used to acquire land and to construct or improve appropriately zoned real property for the creation of income producing or owner user commercial properties. Borrowers are generally required to put equity into each project at levels determined by the appropriate Loan Committee. Commercial land acquisition and construction loans generally are underwritten with a maximum term of 24 months.

 


Substantially all construction draw requests must be presented in writing on American Institute of Architects documents and certified either by the contractor, the borrower and/or the borrower’s architect. Each draw request shall also include the borrower’s soft cost breakdown certified by the borrower or their Chief Financial Officer. Prior to an advance, the Bank or its contractor inspects the project to determine that the work has been completed, to justify the draw requisition.

 

Commercial permanent loans are generally secured by improved real property which is generating income in the normal course of operation. Debt service coverage, assuming stabilized occupancy, must be satisfactory to support a permanent loan. The debt service coverage ratio is ordinarily at least 1.15 to 1.0. As part of the underwriting process, debt service coverage ratios are stress tested assuming a 200 basis point increase in interest rates from their current levels.

 

Commercial permanent loans generally are underwritten with a term not greater than 10 years or the remaining useful life of the property, whichever is lower. The preferred term is between 5 to 7 years, with amortization to a maximum of 25 years.

 

The Company’s loan portfolio includes ADC real estate loans including both investment and owner occupied projects. ADC loans amounted to $1.46$1.62 billion at SeptemberJune 30, 2018.2019. A portion of the ADC portfolio, both speculative and non-speculative, includes loan funded interest reserves at origination. ADC loans that provide for the use of interest reserves represent approximately 77%71% of the outstanding ADC loan portfolio at SeptemberJune 30, 2018.2019. The decision to establish a loan-funded interest reserve is made upon origination of the ADC loan and is based upon a number of factors considered during underwriting of the credit including: (1) the feasibility of the project; (2) the experience of the sponsor; (3) the creditworthiness of the borrower and guarantors; (4) borrower equity contribution; and (5) the level of collateral protection. When appropriate, an interest reserve provides an effective means of addressing the cash flow characteristics of a properly underwritten ADC loan. The Company does not significantly utilize interest reserves in other loan products. The Company recognizes that one of the risks inherent in the use of interest reserves is the potential masking of underlying problems with the project and/or the borrower’s ability to repay the loan. In order to mitigate this inherent risk, the Company employs a series of reporting and monitoring mechanisms on all ADC loans, whether or not an interest reserve is provided, including: (1) construction and development timelines which are monitored on an ongoing basis which track the progress of a given project to the timeline projected at origination; (2) a construction loan administration department independent of the lending function; (3) third party independent construction loan inspection reports; (4) monthly interest reserve monitoring reports detailing the balance of the interest reserves approved at origination and the days of interest carry represented by the reserve balances as compared to the then current anticipated time to completion and/or sale of speculative projects; and (5) quarterly commercial real estate construction meetings among senior Company management, which includes monitoring of current and projected real estate market conditions. If a project has not performed as expected, it is not the customary practice of the Company to increase loan funded interest reserves.


The following tables detail activity in the allowance for credit losses by portfolio segment for the three and ninesix months ended SeptemberJune 30, 20182019 and 2017.2018. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.

 

   

Income

Producing -

Commercial

 

Owner

Occupied - Commercial

 

Real Estate

Mortgage -

 

Construction -

Commercial and

 Home Other   
(dollars in thousands) Commercial Income Producing - Commercial Real Estate Owner Occupied - Commercial Real Estate Real Estate Mortgage Residential Construction - Commercial and Residential Home
Equity		 Other
Consumer		 Total Commercial  Real Estate  Real Estate  Residential  Residential  Equity  Consumer  Total 
Three Months Ended September 30, 2018                                
                 
Three Months Ended June 30, 2019                                
Allowance for credit losses:                                
Balance at beginning of period $17,195  $26,765  $5,980  $681  $18,469  $605  $248  $69,943 
Loans charged-off  (1)  (1,847)  —   —   —   —   (2)  (1,850)
Recoveries of loans previously charged-off  37   302   2   2   37   —   13   393 
Net loans charged-off  36   (1,545)  2   2   37   —   11   (1,457)
Provision for credit losses  905   1,790   (226)  672   500   (24)  (17)  3,600 
Ending balance $18,136  $27,010  $5,756  $1,355  $19,006  $581  $242  $72,086 
                                
Six Months Ended June 30, 2019                                
Allowance for credit losses:                                                                
Balance at beginning of period $12,206  $27,988  $6,003  $757  $18,651  $673  $331  $66,609  $15,857  $28,034  $6,242  $965  $18,175  $599  $72  $69,944 
Loans charged-off  (1,174)  —   —   —   (643)  —   (15)  (1,832)  (5)  (5,343)  —   —   —   —   (2)  (5,350)
Recoveries of loans previously charged-off  60   —   —   1   899   6   5   971   167   302   2   3   37   —   21   532 
Net loans (charged-off) recoveries  (1,114)  —   —   1   256   6   (10)  (861)  162   (5,041)  2   3   37   —   19   (4,818)
Provision for credit losses  4,557   (601)  (72)  (9)  (1,368)  (48)  (18)  2,441   2,117   4,017   (488)  387   794   (18)  151   6,960 
Ending balance $15,649  $27,387  $5,931  $749  $17,539  $631  $303  $68,189  $18,136  $27,010  $5,756  $1,355  $19,006  $581  $242  $72,086 
                                                                
Nine Months Ended September 30, 2018                                
As of June 30, 2019                                
Allowance for credit losses:                                
Individually evaluated for impairment $7,905  $1,000  $475  $650  $—  $—  $—  $10,030 
Collectively evaluated for impairment  10,231   26,010   5,281   705   19,006   581   242   62,056 
Ending balance $18,136  $27,010  $5,756  $1,355  $19,006  $581  $242  $72,086 
                                
Three Months Ended June 30, 2018                                
Allowance for credit losses:                                                                
Balance at beginning of period $13,102  $25,376  $5,934  $944  $18,492  $770  $140  $64,758  $13,358  $26,468  $5,471  $734  $18,742  $699  $335  $65,807 
Loans charged-off  (2,435)  (121)  (132)  —   (1,160)  —   (15)  (3,863)  (408)  —   —   —   (517)  —   —   (925)
Recoveries of loans previously charged-off  86   2   2   4   994   133   13   1,234   23   2   1   1   35   10   5   77 
Net loans (charged-off) recoveries  (2,349)  (119)  (130)  4   (166)  133   (2)  (2,629)  (385)  2   1   1   (482)  10   5   (848)
Provision for credit losses  4,896   2,130   127   (199)  (787)  (272)  165   6,060   (767)  1,518   531   22   391   (36)  (9)  1,650 
Ending balance $15,649  $27,387  $5,931  $749  $17,539  $631  $303  $68,189  $12,206  $27,988  $6,003  $757  $18,651  $673  $331  $66,609 
                                                                
As of September 30, 2018                                
Allowance for credit losses:                                
Individually evaluated for impairment $6,271  $3,043  $500  $—  $—  $—  $56  $9,870 
Collectively evaluated for impairment  9,378   24,344   5,431   749   17,539   631   247   58,319 
Ending balance $15,649  $27,387  $5,931  $749  $17,539  $631  $303  $68,189 
                                
Three Months Ended September 30, 2017                                
Six Months Ended June 30, 2018                                
Allowance for credit losses:                                                                
Balance at beginning of period $14,225  $23,308  $4,189  $1,081  $16,727  $1,216  $301  $61,047  $13,102  $25,376  $5,934  $944  $18,492  $770  $140  $64,758 
Loans charged-off  (522)  —   —   —   (39)  —   (32)  (593)  (1,261)  (121)  (132)  —   (517)  —   —   (2,031)
Recoveries of loans previously charged-off  407   30   —   2   146   1   6   592   26   2   2   3   95   127   8   263 
Net loans (charged-off) recoveries  (115)  30   —   2   107   1   (26)  (1)  (1,235)  (119)  (130)  3   (422)  127   8   (1,768)
Provision for credit losses  (2,266)  (963)  1,273   (126)  4,052   (120)  71   1,921   339   2,731   199   (190)  581   (224)  183   3,619 
Ending balance $11,844  $22,375  $5,462  $957  $20,886  $1,097  $346  $62,967  $12,206  $27,988  $6,003  $757  $18,651  $673  $331  $66,609 
                                                                
Nine Months Ended September 30, 2017                                
Allowance for credit losses:                                
Balance at beginning of period $14,700  $21,105  $4,010  $1,284  $16,487  $1,328  $160  $59,074 
Loans charged-off  (659)  (1,470)  —   —   (39)  —   (98)  (2,266)
Recoveries of loans previously charged-off  675   80   2   5   491   4   18   1,275 
Net loans (charged-off) recoveries  16   (1,390)  2   5   452   4   (80)  (991)
Provision for credit losses  (2,872)  2,660   1,450   (332)  3,947   (235)  266   4,884 
Ending balance $11,844  $22,375  $5,462  $957  $20,886  $1,097  $346  $62,967 
                                
As of September 30, 2017                                
As of June 30, 2018                                
Allowance for credit losses:                                                                
Individually evaluated for impairment $3,246  $1,378  $1,005  $—  $2,900  $90  $81  $8,700  $4,506  $3,543  $500  $—  $—  $—  $80  $8,629 
Collectively evaluated for impairment  8,598   20,997   4,457   957   17,986   1,007   265   54,267   7,700   24,445   5,503   757   18,651   673   251   57,980 
Ending balance $11,844  $22,375  $5,462  $957  $20,886  $1,097  $346  $62,967  $12,206  $27,988  $6,003  $757  $18,651  $673  $331  $66,609 

The Company’s recorded investments in loans as of SeptemberJune 30, 20182019 and December 31, 20172018 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of the Company’s impairment methodology was as follows:

 

(dollars in thousands) Commercial Income Producing - Commercial Real Estate Owner Occupied - Commercial Real Estate Real Estate Mortgage Residential Construction - Commercial and Residential Home
Equity		 Other
Consumer		 Total
                 
September 30, 2018                                
Recorded investment in loans:                                
Individually evaluated for impairment $27,370  $9,404  $5,312  $1,236  $3,030  $487  $92  $46,931 
Collectively evaluated for impairment  1,466,207   3,180,506   857,850   103,628   1,101,133   86,038   2,379   6,797,741 
Ending balance $1,493,577  $3,189,910  $863,162  $104,864  $1,104,163  $86,525  $2,471  $6,844,672 
                                 
December 31, 2017                                
Recorded investment in loans:                                
Individually evaluated for impairment $8,726  $10,192  $5,501  $478  $4,709  $494  $91  $30,191 
Collectively evaluated for impairment  1,367,213   3,036,902   749,943   103,879   1,027,123   92,770   3,507   6,381,337 
Ending balance $1,375,939  $3,047,094  $755,444  $104,357  $1,031,832  $93,264  $3,598  $6,411,528 

     Income Producing -  Owner Occupied -  Real Estate  Construction -          
     Commercial  Commercial  Mortgage -  Commercial and  Home  Other    
(dollars in thousands) Commercial  Real Estate  Real Estate  Residential  Residential  Equity  Consumer  Total 
                         
June 30, 2019                                
Recorded investment in loans:                                
Individually evaluated for impairment $26,980  $37,900  $3,879  $5,367  $9,155  $487  $—  $83,768 
Collectively evaluated for impairment  1,448,221   3,628,915   966,971   99,824   1,079,958   82,960   1,998   7,308,847 
Ending balance $1,475,201  $3,666,815  $970,850  $105,191  $1,089,113  $83,447  $1,998  $7,392,615 
                                 
December 31, 2018                                
Recorded investment in loans:                                
Individually evaluated for impairment $8,738  $61,747  $5,307  $1,228  $7,012  $487  $—  $84,519 
Collectively evaluated for impairment  1,544,374   3,195,153   882,507   105,190   1,090,600   86,116   2,988   6,906,928 
Ending balance $1,553,112  $3,256,900  $887,814  $106,418  $1,097,612  $86,603  $2,988  $6,991,447 

 

At SeptemberJune 30, 2018,2019, nonperforming loans acquired from Fidelity & Trust Financial Corporation (“Fidelity”) and Virginia Heritage Bank (“Virginia Heritage”) have a carrying value of $287$273 thousand and $394$155 thousand, respectively, and an unpaid principal balance of $337$323 thousand and $1.2 million,$968 thousand, respectively, and were evaluated separately in accordance with ASC Topic 310-30,“Loans and Debt Securities Acquired with Deteriorated Credit Quality.” At December 31, 2017,2018, nonperforming loans acquired from Fidelity and Virginia Heritage had a carrying value of $297$282 thousand and $479$202 thousand, respectively, and an unpaid principal balance of $347$332 thousand and $1.5 million,$995 thousand, respectively, and were evaluated separately in accordance with ASC Topic 310-30. The various impaired loans were recorded at estimated fair value with any excess being charged-off or treated as a non-accretable discount. Subsequent downward adjustments to the valuation of impaired loans acquired will result in additional loan loss provisions and related allowance for credit losses.


Credit Quality Indicators

 

The Company uses several credit quality indicators to manage credit risk in an ongoing manner. The Company’s primary credit quality indicators are to use an internal credit risk rating system that categorizes loans into pass, watch, special mention, or classified categories. Credit risk ratings are applied individually to those classes of loans that have significant or unique credit characteristics that benefit from a case-by-case evaluation. These are typically loans to businesses or individuals in the classes which comprise the commercial portfolio segment. Groups of loans that are underwritten and structured using standardized criteria and characteristics, such as statistical models (e.g., credit scoring or payment performance), are typically risk rated and monitored collectively. These are typically loans to individuals in the classes which comprise the consumer portfolio segment.

 

The following are the definitions of the Company’s credit quality indicators:

 

Pass:Loans in all classes that comprise the commercial and consumer portfolio segments that are not adversely rated, are contractually current as to principal and interest, and are otherwise in compliance with the contractual terms of the loan agreement. Management believes that there is a low likelihood of loss related to those loans that are considered pass.

 

Watch:Loan paying as agreed with generally acceptable asset quality; however the obligor’s performance has not met expectations. Balance sheet and/or income statement has shown deterioration to the point that the obligor could not sustain any further setbacks. Credit is expected to be strengthened through improved obligor performance and/or additional collateral within a reasonable period of time.

 

Special Mention:Loans in the classes that comprise the commercial portfolio segment that have potential weaknesses that deserve management’s close attention. If not addressed, these potential weaknesses may result in deterioration of the repayment prospects for the loan. The special mention credit quality indicator is not used for classes of loans that comprise the consumer portfolio segment. Management believes that there is a moderate likelihood of some loss related to those loans that are considered special mention.

 

Classified:Classified (a) Substandard - Loans inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the company will sustain some loss if the deficiencies are not corrected. Loss potential, while existing in the aggregate amount of substandard loans, does not have to exist in individual loans classified substandard.
Classified (b) Doubtful - Loans that have all the weaknesses inherent in a loan classified substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the assets, its classification as an estimated loss is deferred until its more exact status may be determined.

Classified (b) Doubtful - Loans that have all the weaknesses inherent in a loan classified substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high, but because of certain important and reasonably specific pending factors, which may work to the advantage and strengthening of the assets, its classification as an estimated loss is deferred until its more exact status may be determined.


The Company'sCompany’s credit quality indicators are updated generally on a quarterly basis, but no less frequently than annually. The following table presents by class and by credit quality indicator, the recorded investment in the Company'sCompany’s loans and leases as of SeptemberJune 30, 20182019 and December 31, 2017.2018.

 

              
(dollars in thousands) Pass  

Watch and

Special Mention

  Substandard  Doubtful  

Total

Loans

 
                
September 30, 2018                    
Commercial $1,444,780  $21,427  $27,370  $—  $1,493,577 
Income producing - commercial real estate  3,156,777   23,729   9,404   —   3,189,910 
Owner occupied - commercial real estate  821,647   36,203   5,312   —   863,162 
Real estate mortgage – residential  102,979   649   1,236   —   104,864 
Construction - commercial and residential  1,101,133   —   3,030   —   1,104,163 
Home equity  85,352   686   487   —   86,525 
Other consumer  2,379   —   92   —   2,471 
          Total $6,715,047  $82,694  $46,931  $—  $6,844,672 
                     
December 31, 2017                    
Commercial $1,333,050  $34,163  $8,726  $—  $1,375,939 
Income producing - commercial real estate  3,033,046   3,856   10,192   —   3,047,094 
Owner occupied - commercial real estate  696,754   53,189   5,501   —   755,444 
Real estate mortgage – residential  103,220   659   478   —   104,357 
Construction - commercial and residential  1,027,123   ���   4,709   —   1,031,832 
Home equity  92,084   686   494   —   93,264 
Other consumer  3,505   2   91   —   3,598 
          Total $6,288,782  $92,555  $30,191  $—  $6,411,528 

     Watch and        Total 
(dollars in thousands) Pass  Special Mention  Substandard  Doubtful  Loans 
                
June 30, 2019                    
Commercial $1,398,098  $50,123  $26,980  $—  $1,475,201 
Income producing - commercial real estate  3,611,968   16,947   37,900   —   3,666,815 
Owner occupied - commercial real estate  924,643   42,328   3,879   —   970,850 
Real estate mortgage – residential  99,188   636   5,367   —   105,191 
Construction - commercial and residential  1,079,958   —   9,155   —   1,089,113 
Home equity  82,274   686   487   —   83,447 
Other consumer  1,998   —   —   —   1,998 
          Total $7,198,127  $110,720  $83,768  $—  $7,392,615 
                     
December 31, 2018                    
Commercial $1,505,477  $25,584  $22,051  $—  $1,553,112 
Income producing - commercial real estate  3,172,479   1,536   82,885   —   3,256,900 
Owner occupied - commercial real estate  844,286   38,221   5,307   —   887,814 
Real estate mortgage – residential  104,543   647   1,228   —   106,418 
Construction - commercial and residential  1,090,600   —   7,012   —   1,097,612 
Home equity  85,434   682   487   —   86,603 
Other consumer  2,988   —   —   —   2,988 
          Total $6,805,807  $66,670  $118,970  $—  $6,991,447 

 

Nonaccrual and Past Due Loans

 

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 20


The following table presents, by class of loan, information related to nonaccrual loans as of SeptemberJune 30, 20182019 and December 31, 2017.2018.

 

(dollars in thousands) September 30, 2018  December 31, 2017 
       
Commercial $7,529  $3,493 
Income producing - commercial real estate  48   832 
Owner occupied - commercial real estate  2,370   5,501 
Real estate mortgage - residential  1,522   775 
Construction - commercial and residential  3,030   2,052 
Home equity  487   494 
Other consumer  91   91 
Total nonaccrual loans (1)(2) $15,077  $13,238 

(dollars in thousands) June 30,
2019		  December 31,
2018		 
       
  Commercial $16,053  $7,115 
  Income producing - commercial real estate  4,563   1,766 
  Owner occupied - commercial real estate  1,510   2,368 
  Real estate mortgage - residential  5,640   1,510 
  Construction - commercial and residential  9,155   3,031 
  Home equity  487   487 
  Total nonaccrual loans (1)(2) $37,408  $16,277 

 

(1)Excludes troubled debt restructurings (“TDRs”) that were performing under their restructured terms totaling $17.5$8.6 million at SeptemberJune 30, 20182019 and $12.3$24.0 million at December 31, 2017.2018.

(2)Gross interest income of $707 thousand$1.2 million and $802$321 thousand would have been recorded for the ninesix months ended SeptemberJune 30, 20182019 and 2017,2018, respectively, if nonaccrual loans shown above had been current and in accordance with their original terms, while the interest actually recorded on such loans was $193$86 thousand and $56$6 thousand for the ninesix months ended SeptemberJune 30, 20182019 and 2017,2018, respectively. See Note 1 to the Consolidated Financial Statements for a description of the Company’s policy for placing loans on nonaccrual status.

The following table presents, by class of loan, an aging analysis and the recorded investments in loans past due as of SeptemberJune 30, 20182019 and December 31, 2017.2018.

 

  Loans  Loans  Loans        Total Recorded 
  30-59 Days  60-89 Days  90 Days or  Total Past  Current  Investment in 
(dollars in thousands) Past Due  Past Due  More Past Due  Due Loans  Loans  Loans 
                   
September 30, 2018                        
Commercial $4,297  $1,247  $7,529  $13,073  $1,480,504  $1,493,577 
Income producing - commercial real estate  763   398   48   1,209   3,188,701   3,189,910 
Owner occupied - commercial real estate  4,500   4,806   2,370   11,676   851,486   863,162 
Real estate mortgage – residential  —   —   1,522   1,522   103,342   104,864 
Construction - commercial and residential  21,947   1,849   3,030   26,826   1,077,337   1,104,163 
Home equity  326   —   487   813   85,712   86,525 
Other consumer  4   —   91   95   2,376   2,471 
          Total $31,837  $8,300  $15,077  $55,214  $6,789,458  $6,844,672 
                         
December 31, 2017                        
Commercial $2,705  $748  $3,493  $6,946  $1,368,993  $1,375,939 
Income producing - commercial real estate  4,398   6,930   832   12,160   3,034,934   3,047,094 
Owner occupied - commercial real estate  522   3,906   5,501   9,929   745,515   755,444 
Real estate mortgage – residential  6,993   1,244   775   9,012   95,345   104,357 
Construction - commercial and residential  —   5,268   2,052   7,320   1,024,512   1,031,832 
Home equity  307   —   494   801   92,463   93,264 
Other consumer  45   6   91   142   3,456   3,598 
          Total $14,970  $18,102  $13,238  $46,310  $6,365,218  $6,411,528 

  Loans  Loans  Loans        Total Recorded 
  30-59 Days  60-89 Days  90 Days or  Total Past  Current  Investment in 
(dollars in thousands) Past Due  Past Due  More Past Due  Due Loans  Loans  Loans 
                   
June 30, 2019                        
Commercial $4,784  $1,112  $16,053  $21,949  $1,453,252  $1,475,201 
Income producing - commercial real estate  2,253   4,656   4,563   11,472   3,655,343   3,666,815 
Owner occupied - commercial real estate  445   3,654   1,510   5,609   965,241   970,850 
Real estate mortgage – residential  —   —   5,640   5,640   99,551   105,191 
Construction - commercial and residential  2,011   1,866   9,155   13,032   1,076,081   1,089,113 
Home equity  1,413   47   487   1,947   81,500   83,447 
Other consumer  21   10   —   31   1,967   1,998 
Total $10,927  $11,345  $37,408  $59,680  $7,332,935  $7,392,615 
                         
December 31, 2018                        
Commercial $4,535  $2,870  $7,115  $14,520  $1,538,592  $1,553,112 
Income producing - commercial real estate  5,855   27,479   1,766   35,100   3,221,800   3,256,900 
Owner occupied - commercial real estate  5,051   2,370   2,368   9,789   878,025   887,814 
Real estate mortgage – residential  2,456   1,698   1,510   5,664   100,754   106,418 
Construction - commercial and residential  4,392   —   3,031   7,423   1,090,189   1,097,612 
Home equity  630   47   487   1,164   85,439   86,603 
Other consumer  —   —   —   —   2,988   2,988 
Total $22,919  $34,464  $16,277  $73,660  $6,917,787  $6,991,447 

 

Impaired Loans

 

Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged offcharged-off when deemed uncollectible.


The following table presents, by class of loan, information related to impaired loans for the periods ended SeptemberJune 30, 20182019 and December 31, 2017.2018.

 

 Unpaid Recorded Recorded             
 Unpaid
Contractual		 Recorded
Investment		 Recorded
Investment		 Total   Average Recorded Investment Interest Income Recognized  Contractual Investment Investment Total   Average Recorded Investment Interest Income Recognized 
 Principal With No With Recorded Related Quarter Year Quarter Year  Principal With No With Recorded Related Quarter Year Quarter Year 
(dollars in thousands) Balance  Allowance  Allowance  Investment  Allowance  To Date  To Date  To Date  To Date  Balance  Allowance  Allowance  Investment  Allowance  To Date  To Date  To Date  To Date 
                                      
September 30, 2018                                    
June 30, 2019                                    
Commercial $12,943  $—  $12,471  $12,471  $6,271  $10,234  $8,431  $277  $316  $17,434  $5,003  $11,959  $16,962  $7,905  $14,972  $12,695  $84  $103 
Income producing - commercial real estate  9,260   —   9,260   9,260   3,043   9,292   9,277   120   361   8,953   4,563   4,390   8,953   1,000   24,198   23,266   (165)  98 
Owner occupied - commercial real estate  5,761   449   5,312   5,761   500   5,940   6,104   125   149   4,819   3,449   1,370   4,819   475   4,836   5,134   47   93 
Real estate mortgage – residential  1,522   1,522   —   1,522   —   1,749   1,747   —   2   5,640   3,184   2,456   5,640   650   5,642   4,265   —   — 
Construction - commercial and residential  3,030   3,030   —   3,030   —   1,515   1,694   68   68   10,315   9,155   —   9,155   —   6,093   5,072   15   15 
Home equity  487   487   —   487   —   491   492   —   —   487   487   —   487   —   487   487   —   — 
Other consumer  92   —   92   92   56   92   91   —   —   —   —   —   —   —   —   —   —   — 
Total $33,095  $5,488  $27,135  $32,623  $9,870  $29,313  $27,836  $590  $896  $47,648  $25,841  $20,175  $46,016  $10,030  $56,228  $50,919  $(19) $309 
                                                                        
December 31, 2017                                    
December 31, 2018                                    
Commercial $5,644  $1,777  $3,748  $5,525  $3,259  $5,764  $5,765  $48  $145  $8,613  $2,057  $6,084  $8,141  $4,803  $10,306  $8,359  $(126) $190 
Income producing - commercial real estate  10,044   781   9,263   10,044   2,380   10,068   10,127   120   493   21,402   1,720   19,682   21,402   2,465   15,331   12,309   189   550 
Owner occupied - commercial real estate  6,596   1,095   5,501   6,596   1,382   6,743   5,210   27   73   5,731   4,361   1,370   5,731   600   5,746   6,011   47   196 
Real estate mortgage – residential  775   775   —   775   —   538   423   17   17   1,510   1,510   —   1,510   —   1,516   1,688   —   2 
Construction - commercial and residential  2,052   1,534   518   2,052   500   3,491   3,731   (14)  —   3,031   3,031   —   3,031   1,050   3,031   2,028   —   68 
Home equity  494   494   —   494   —   544   346   —   2   487   487   —   487   —   487   491   —   — 
Other consumer  91   —   91   91   80   92   93   —   —   —   —   —   —   —   46   69   —   — 
Total $25,696  $6,456  $19,121  $25,577  $7,601  $27,240  $25,695  $198  $730  $40,774  $13,166  $27,136  $40,302  $8,918  $36,463  $30,955  $110  $1,006 

 

Modifications

 

A modification of a loan constitutes a TDR when a borrower is experiencing financial difficulty and the modification constitutes a concession. The Company offers various types of concessions when modifying a loan. Commercial and industrial loans modified in a TDR often involve temporary interest-only payments, term extensions, and converting revolving credit lines to term loans. Additional collateral, a co-borrower, or a guarantor is often requested. Commercial mortgage and construction loans modified in a TDR often involve reducing the interest rate for the remaining term of the loan, extending the maturity date at an interest rate lower than the current market rate for new debt with similar risk, or substituting or adding a new borrower or guarantor. Construction loans modified in a TDR may also involve extending the interest-only payment period. As of SeptemberJune 30, 2018,2019, all performing TDRs were categorized as interest-only modifications.

 

Loans modified in a TDR for the Company may have the financial effect of increasing the specific allowance associated with the loan. An allowance for impaired consumer and commercial loans that have been modified in a TDR is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the estimated fair value of the collateral, less any selling costs, if the loan is collateral dependent. Management exercises significant judgment in developing these estimates.


The following table presents by class, the recorded investment of loans modified in TDRs held by the Company for the periods ended SeptemberJune 30, 20182019 and December 31, 2017.2018.

  For the Six Months Ended June 30, 2019 
  Number of     Income Producing -  Owner Occupied -  Construction -    
(dollars in thousands) Contracts  Commercial  Commercial Real Estate  Commercial Real Estate  Commercial Real Estate  Total 
Troubled debt restructurings                        
     Restructured accruing  7  $909  $4,390  $3,309  $—  $8,608 
     Restructured nonaccruing  4   2,831   —   —   —   2,831 
Total  11  $3,740  $4,390  $3,309  $—  $11,439 
                         
Specific allowance     $—  $1,000  $—  $—  $1,000 
                         
Restructured and subsequently defaulted     $    $2,300  $—  $—  $1,847 

 

  For the Nine Months Ended September 30, 2018 
        Income
Producing -		  Owner
Occupied -		  Construction -    
(dollars in thousands) Number of
Contracts		  Commercial  Commercial
Real Estate		  Commercial
Real Estate		  Commercial
Real Estate		  Total 
Troubled debt restructurings                        
     Restructured accruing  10  $4,942  $9,212  $3,391  $—  $17,545 
     Restructured nonaccruing  4   723   —   —   —   723 
Total  14  $5,665  $9,212  $3,391  $—  $18,268 
                         
Specific allowance     $2,000  $3,500  $—  $—  $5,500 
                         
Restructured and subsequently defaulted     $—  $937  $—  $—  $937 

                   
  For the Year Ended December 31, 2017 
       Income
Producing -		  Owner
Occupied -		  Construction -    
(dollars in thousands) Number of
Contracts		  Commercial  Commercial
Real Estate		  Commercial
Real Estate		  Commercial
Real Estate		  Total 
Troubled debt restructings                        
     Restructured accruing  9  $2,032  $9,212  $1,095  $—  $12,339 
     Restructured nonaccruing  5   867   121   —   —   988 
Total  14  $2,899  $9,333  $1,095  $—  $13,327 
                         
Specific allowance     $595  $2,350  $—  $—  $2,945 
                         
Restructured and subsequently defaulted     $237  $—  $—  $—  $237 

  For the Six Months Ended June 30, 2018 
  Number of     Income Producing -  Owner Occupied -  Construction -    
(dollars in thousands) Contracts  Commercial  Commercial Real Estate  Commercial Real Estate  Commercial Real Estate  Total 
Troubled debt restructings                        
     Restructured accruing  9  $4,938  $9,138  $1,047  $—  $15,123 
     Restructured nonaccruing  4   1,211   —   —   —   1,211 
Total  13  $6,149  $9,138  $1,047  $—  $16,334 
                         
Specific allowance     $2,000  $3,500  $—  $—  $5,500 
                         
Restructured and subsequently defaulted     $—  $937  $—  $—  $937 

 

The Company had fourteeneleven TDR’s at SeptemberJune 30, 20182019 totaling approximately $18.3$11.4 million. TenSeven of these loans totaling approximately $17.5$8.6 million are performing under their modified terms. There was one performing TDR totaling $2.3 million that defaulted on its modified terms which was reclassified to nonperforming loans during the six months ended June 30, 2019. During the six months ended June 30, 2018, there were two performing TDRs totaling $937 thousand that defaulted on their modified terms which were reclassified to nonperforming loans during the nine months ended September 30, 2018, as compared to the same period in 2017, which had one default on a $237 thousand restructured loan which was charged off.loans. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual. For the three months ended June 30, 2019, there was one restructured loan totaling approximately $4.8 million that had its collateral property sold for approximately $3 million and the remaining $1.8 million was charged-off during the quarter, as compared to the same period in 2018, there was one defaulted loan totaling approximately $315 thousand that was charged-off.  During the three months ended June 30, 2019, there was one loan totaling $10.4 million that was re-underwritten into two new loans which provided better collateral for the Bank, as compared to the three months ended June 30, 2018, there was one loan totaling $274 thousand that was partially paid off from the sale proceeds of the business which totaled approximately $236 thousand. The remaining balance on the loan of $38 thousand was charged-off. Commercial and consumer loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. The allowance may be increased, adjustments may be made in the allocation of the allowance, or partial charge-offs may be taken to further write-down the carrying value of the loan. For the three months ended SeptemberJune 30, 20108,2019, there was one loan totaling $2.4 millionwere no loans modified in a TDR, as compared to the three months ended SeptemberJune 30, 20172018 which had two loans totaling $251 thousand modified in a TDR. For the nine months ended September 31, 2018, there were three loans totaling $6.4 million modified in a TDR, as compared to the nine months ended September 30, 2017 which had three loans totaling $5.1$4.0 million modified in a TDR.

 

Note 6. Leases

A lease is defined as a contract that conveys the right to control the use of identified property, plant or equipment for a period of time in exchange for consideration. On January 1, 2019, the Company adopted ASU No. 2016-02“Leases” (Topic 842) and all subsequent ASUs that modified Topic 842. For the Company, Topic 842 primarily affected the accounting treatment for operating lease agreements in which the Company is the lessee.

Substantially all of the leases in which the Company is the lessee are comprised of real estate property for branch offices, ATM locations, and corporate office space. Substantially all of our leases are classified as operating leases, and as such, were previously not recognized on the Company’s consolidated statements of condition. With the adoption of Topic 842, operating lease agreements were required to be recognized on the consolidated statements of condition as a right-of-use (“ROU”) asset and a corresponding lease liability.


As of June 30, 2019, the Company had $28.2 million of operating lease ROU assets and $31.7 million of operating lease liabilities on the Company’s Consolidated Balance Sheet. The Company elects not to recognize ROU assets and lease liabilities arising from short-term leases, leases with initial terms of twelve months or less, or equipment leases (deemed immaterial) on the Consolidated Statements of Condition.

Our leases contain terms and conditions of options to extend or terminate the lease which are recognized as part of the ROU assets and lease liabilities when an economic benefit to exercise the option exists and there is a 90% probability that the Company will exercise the option. If these criteria are not met, the options are not included in our ROU assets and lease liabilities.

As of June 30, 2019, our leases do not contain material residual value guarantees or impose restrictions or covenants related to dividends or the Company’s ability to incur additional financial obligations. As of June 30, 2019, there were no leases that have been signed but did not yet commence as of the reporting date that create significant rights and obligations for the Company.

The following table presents lease costs and other lease information.

  Six Months Ended 
(dollars in thousands) June 30, 2019 
Lease Cost    
Operating Lease Cost (Cost resulting from lease payments) $3,898 
Variable Lease Cost (Cost excluded from lease payments)  535 
Sublease Income  (188)
Net Lease Cost $4,245 
     
Operating Lease - Operating Cash Flows (Fixed Payments) $4,246 
Operating Lease - Operating Cash Flows (Liability Reduction)  3,619 
Right-of-Use Assets - Operating Leases  28,214 
Weighted Average Lease Term - Operating Leases  5.59 yrs 
Weighted Average Discount Rate - Operating Leases  4.00%

Future minimum payments for operating leases with initial or remaining terms of one year or more as of June 30, 2019 were as follows:

(dollars in thousands)   
Twelve Months Ended:   
June 30, 2020 $8,581 
June 30, 2021  8,104 
June 30, 2022  6,541 
June 30, 2023  4,500 
June 29, 2024  3,895 
Thereafter  5,140 
Total Future Minimum Lease Payments  36,761 
Amounts Representing Interest  (5,102)
Present Value of Net Future Minimum Lease Payments $31,659 

Note 7 – Affordable Housing Projects Tax Credit Partnerships

Included in Other Assets, the Company makes equity investments in various limited partnerships that sponsor affordable housing projects utilizing the Low Income Housing Tax Credit (“LIHTC”) pursuant to Section 42 of the Internal Revenue Code. The purpose of these investments is to achieve a satisfactory return on capital, to facilitate the sale of affordable housing products offerings, and to assist in achieving goals associated with the Community Reinvestment Act. The primary activities of the limited partnerships include the identification, development, and operation of multi-family housing that is leased to qualifying residential tenants. Generally, these types of investments are funded through a combination of debt and equity.

The Company is a limited partner in each LIHTC limited partnership. Each limited partnership is managed by an unrelated third party general partner who exercises significant control over the affairs of the limited partnership. The general partner has all the rights, powers and authority granted or permitted to be granted to a general partner of a limited partnership. Duties entrusted to the general partner of each limited partnership include, but are not limited to: investment in operating companies, company expenditures, investment of excess funds, borrowing funds, employment of agents, disposition of fund property, prepayment and refinancing of liabilities, votes and consents, contract authority, disbursement of funds, accounting methods, tax elections, bank accounts, insurance, litigation, cash reserve, and use of working capital reserve funds. Except for limited rights granted to the limited partner(s) relating to the approval of certain transactions, the limited partner(s) may not participate in the operation, management, or control of the limited partnership’s business, transact any business in the limited partnership’s name or have any power to sign documents for or otherwise bind the limited partnership. In addition, the general partner may only be removed by the limited partner(s) in the event the general partner fails to comply with the terms of the agreement or is negligent in performing its duties.

The general partner of each limited partnership has both the power to direct the activities which most significantly affect the performance of each partnership and the obligation to absorb losses or the right to receive benefits that could be significant to the entities. Therefore, the Company has determined that it is not the primary beneficiary of any LIHTC partnership. The Company accounts for its affordable housing tax credit investments using the proportional amortization method. The Company’s net affordable housing tax credit investments were $28.8 million and related unfunded commitments were $15.2 million as of June 30, 2019 and are included in Other Assets and Other Liabilities in the Consolidated Statements of Condition. The Company’s net affordable housing tax credit investments were $28.2 million and related unfunded commitments were $15.0 million as of December 31, 2018.

Note 8. Other Derivatives

The Company is exposed to certain risk arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of its assets and liabilities and the use of derivative financial instruments.

Cash Flow Hedges of Interest Rate Swap DerivativesRisk

 

The Company uses interest rate swap agreements to assist in its interest rate risk management. The Company’s objective in using interest rate derivatives designated as cash flow hedges is to add stability to interest expense and to better manage its exposure to interest rate movements. To accomplish this objective, the Company entered into forward startingutilizes interest rate swaps in April 2015 as part of its interest rate risk management strategy intended to mitigate the potential risk of rising interest rates on the Bank’s cost of funds. The notional amounts of the interest rate swaps designated as cash flow hedges do not represent amounts exchanged by the counterparties, but rather, the notional amount is used to determine, along with other terms of the derivative, the amounts to be exchanged between the counterparties. The interest rate swaps are designated as cash flow hedges and involve the receipt of variable rate amounts from two counterpartiesone counterparty in exchange for the Company making fixed payments beginning in April 2016.payments. The Company’s intent is to hedge its exposure to the variability in potential future interest rate conditions on existing financial instruments.


As of September 30, 2018, the Company had three forward starting designated cash flow hedge interest rate swap transactions outstanding that had an aggregate notional amount of $250 million associated with the Company’s variable rate deposits. The net unrealized gain before income tax on the swaps was $6.4 million at September 30, 2018 compared to a net unrealized gain before income tax of $2.3 million at December 31, 2017. The unrealized gain in value since year end 2017 is due to the increase in expected net cash inflows from the swap over its remaining term due to higher market interest rates.

 

For derivatives designated as cash flow hedges, changes in the fair value of the derivative are initially reported in other comprehensive income (outside of earnings), net of tax, and subsequently reclassified to earnings when the hedged transaction affects earnings. The Company assesses the effectiveness of each hedging relationship by comparing the changes in cash flows of the derivative hedging instrument with the changes in cash flows of the designated hedged transactions.


As of June 30, 2019, the Company had one designated cash flow hedge notional interest rate swap transaction outstanding amounting to $100 million associated with the Company’s variable rate deposits, as compared to three designated cash flow hedge notional interest rate swap transactions outstanding as of December 31, 2018 amounting to $250 million associated with the Company’s variable rate deposits. The decline in the amount of hedged variable rate deposits was due to a reduction in such deposits. The net unrealized loss before income tax on the swap was $101 thousand at June 30, 2019 compared to a net unrealized gain before income tax of $3.7 million at December 31, 2018. The unrealized loss in value since year end 2018 was due to the termination of two of the interest rate swap transactions as part of the Company’s asset liability strategy. As a result of the swap terminations, the Company recognized $829 thousand in noninterest income during March 2019. Additionally, the Company will amortize $372 thousand of realized gain as a reduction to interest expense through the swap’s original maturity date of March 31, 2020.

 

Amounts reported in accumulated other comprehensive income related to designated cash flow hedge derivatives will be reclassified to interest income/expense as interest payments are made/received on the Company’s variable-rate assets/liabilities.During the three and nine monthsquarter ended SeptemberJune 30, 2018,2019, the Company reclassified $214 and $230$313 thousand respectively, related to designated cash flow hedge derivatives from accumulated other comprehensive income to decrease interest expense. During the three and nine months ended September 30, 2017, the Company reclassified $307 and $1.3 million, respectively, related to designated cash flow hedge derivatives from accumulated other comprehensive income to increase interest expense.During the next twelve months, the Company estimates (based on existing interest rates) that $2.1 million$114 thousand will be reclassified as a decrease in interest expense.

Non-designated Hedges

Derivatives not designated as hedges are not speculative and result from a service the Company provides to certain customers. The Company executes interest rate caps and swaps with commercial banking customers to facilitate their respective risk management strategies. Those interest rate swaps are simultaneously hedged by offsetting derivatives that the Company executes with a third party, such that the Company minimizes its net risk exposure resulting from such transactions. As the interest rate derivatives associated with this program do not meet the strict hedge accounting requirements, changes in the fair value of both the customer derivatives and the offsetting derivatives are recognized directly in earnings.

The Company entered into credit risk participation agreements (“RPAs”) with institutional counterparties, under which the Company assumes its pro-rata share of the credit exposure associated with a borrower’s performance related to interest rate derivative contracts. The fair value of RPAs is calculated by determining the total expected asset or liability exposure of the derivatives to the borrowers and applying the borrowers’ credit spread to that exposure. Total expected exposure incorporates both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities.

Credit-risk-related Contingent Features

The Company has agreements with each of its derivative counterparties that contain a provision where if the Company defaults on any of its indebtedness, then the Company could also be declared in default on its derivative obligations.

 

The Company is exposed to credit risk in the event of nonperformance by the interest rate swapderivative counterparty. The Company minimizes this risk by entering into derivative contracts with only large, stable financial institutions, and the Company has not experienced, and does not expect, any losses from counterparty nonperformance on the interest rate swaps.derivatives. The Company monitors counterparty risk in accordance with the provisions of ASC Topic 815,“Derivatives and Hedging.”In addition, the interest rate swapderivative agreements contain language outlining collateral-pledging requirements for each counterparty. Collateral must be posted when the market value exceeds certain threshold limits.

 

The designated cash flow hedge interest rate swapderivative agreements detail: 1) that collateral be posted when the market value exceeds certain threshold limits associated with the secured party’s exposure; 2) if the Company defaults on any of its indebtedness (including default where repayment of the indebtedness has not been accelerated by the lender), then the Company could also be declared in default on its derivative obligations; 3) if the Company fails to maintain its status as a well capitalized institution then the counterparty could terminate the derivative positions and the Company would be required to settle its obligations under the agreements.

 

As of SeptemberJune 30, 2018,2019, the aggregate fair value of all designated cash flow hedge derivative contracts with credit risk contingent features (i.e., those containing collateral posting or termination provisions based on our capital status) that were in a net asset position totaled $5.8 million (none of these contracts werewas in a net liability position as of September 30, 2018).totaled $101 thousand. The Company has a minimum collateral posting thresholdsthreshold with certain of its derivative counterparties.counterparty. As of SeptemberJune 30, 2018,2019, the Company was not required to post collateral with its derivative counterpartiescounterparty against its obligations under these agreements because these agreements were in a net asset position.this agreement. If the Company had breached any provisions under the agreementsagreement at SeptemberJune 30, 2018,2019, it could have been required to settle its obligations under the agreementsagreement at the termination value.

During the third quarter of 2018, the Company entered into credit risk participation agreements (“RPAs”) with institutional counterparties, under which the Company assumes its pro-rata share of the credit exposure associated with a borrower’s performance related to interest rate derivative contracts. The fair value of RPAs is calculated by determining the total expected asset or liability exposure of the derivatives to the borrowers and applying the borrowers’ credit spread to that exposure. Total expected exposure incorporates both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities. These derivatives are not designated as hedges, are not speculative, and have a notional value of $27.5 million as of September 30. 2018. The changes in fair value for these contracts are recognized directly in earnings.


The table below identifies the balance sheet category and fair valuesvalue of the Company’s designated cash flow hedge derivative instruments and non-designated hedges as of SeptemberJune 30, 20182019 and December 31, 2017.2018.

 

 June 30, 2019 December 31, 2018
    September 30, 2018 December 31, 2017 Notional   Balance Sheet Notional   Balance Sheet
 Swap Notional   Balance Sheet Notional   Balance Sheet Amount Fair Value Category Amount Fair Value Category
 Number  Amount  Fair Value  Category Amount  Fair Value  Category        
Derivatives designated as hedging instrumentsDerivatives designated as hedging instruments       Derivatives designated as hedging instruments     
                    
(dollars in thousands)                                 
Interest rate swap  (1) $75,000  $1,240  Other Assets $75,000  $598  Other Assets
Interest rate swap  (2)  100,000   2,539  Other Assets  100,000   821  Other Assets
Interest rate swap  (3)  75,000   2,648  Other Assets  75,000   837  Other Assets
Interest rate product $—    $—    Other Assets $250,000  $3,727  Other Assets
   Total   $250,000  $6,427  $250,000  $2,256                   
                 
(dollars in thousands)                 
Interest rate product $100,000  $101  Other Liabilities $—    $—    Other Liabilities
                                      
Derivatives not designated as hedging instrumentsDerivatives not designated as hedging instruments              Derivatives not designated as hedging instruments         
                                      
(dollars in thousands)                                      
Interest rate product $26,000  $41  Other Assets $—    $—    Other Assets
                 
(dollars in thousands)                 
Interest rate product $26,000  $40  Other Liabilities $—    $—    Other Liabilities
Other Contracts  (1)  27,500   29  Other Liabilities  —   —  Other Liabilities  27,500   101  Other Liabilities  27,500   59  Other Liabilities
   Total   $27,500  $29  $—  $—   $53,500  $141  Other Liabilities $27,500  $59  Other Liabilities

 

The table below presents the pre-tax net gains (losses) of the Company’s designated cash flow hedges for the three and ninesix months ended SeptemberJune 30, 20182019 and 2017.2018.

Derivatives in Subtopic 815-20 Hedging Relationships (dollars in thousands) Amount of Gain or (Loss) Recognized in OCI on Derivative Location of Gain or (Loss) Recognized from Accumulated Other Comprehensive Income into Income  Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income 
  Three Months Ended June 30,   ThreeMonths Ended June 30, 
  2019 2018   2019  2018 
Derivatives in Cash Flow Hedging Relationships          
Interest Rate Products $(834) $1,109  Interest Expense $313  $104 
Total $(834) $1,109    $313  $104 

 

     Three Months Ended September 30, 2018  Three Months Ended September 30, 2017 
     Amount of  Reclassified from AOCI into Income  Amount of  Reclassified from AOCI into Income 
  Swap  Pre-tax gain    Amount of  Pre-tax (loss)    Amount of 
  Number  Recognized in OCI  Category Gain (Loss)  Recognized in OCI  Category (Loss) 
                    
(dollars in thousands)                     
Interest rate swap  (1) $111   Interest Expense $90  $26   Interest Expense $(72)
Interest rate swap  (2)  426   Interest Expense  73   (8)  Interest Expense  (122)
Interest rate swap  (3)  312   Interest Expense  51   (56)  Interest Expense  (113)
    Total   $849    $214  $(38)   $(307)
Derivatives in Subtopic 815-20 Hedging Relationships
(dollars in thousands)		 Amount of Gain or (Loss) Recognized in OCI on Derivative Location of Gain or (Loss) Recognized from Accumulated Other Comprehensive Income into Income Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income
  Six Months Ended June 30,   Six Months Ended June 30,
  2019 2018   2019 2018
Derivatives in Cash Flow Hedging Relationships                
Interest Rate Products $(1,867) $3,552  Interest Expense $775  $16 
Interest Rate Products  —     —    Gain on sale of investment securities  829   —   
Total $(1,867) $3,552    $1,604  $16 

 

      Nine Months Ended September 30, 2018  Nine Months Ended September 30, 2017 
       Reclassified from AOCI into Income    Reclassified from AOCI into Income 
   Swap Number   

Amount of

Pre-tax gain

Recognized in OCI

 Category 

Amount of

Gain (Loss)

  

Amount of

Pre-tax (loss)

Recognized in OCI

  Category 

Amount of

(Loss)

 
                         
(dollars in thousands)                     
Interest rate swap  (1) $791   Interest Expense $148  $(26)  Interest Expense $(338)
Interest rate swap  (2)  1,769   Interest Expense  51   (35)  Interest Expense  (525)
Interest rate swap  (3)  1,841   Interest Expense  31   (400)  Interest Expense  (458)
    Total   $4,401    $230  $(461)   $(1,321)


The table below presents the effect of the Company’s derivative financial instruments on the Consolidated Statements of Operations for the three and ninesix months ended SeptemberJune 30, 20182019 and 2017.2018.

The Effect of Fair Value and Cash Flow Hedge Accounting on the Statement of Financial Performance

                 
  

Location and Amount of Gain or (Loss) Recognized in Income on Cash Flow Hedging Relationships

 
  Three Months Ended September 30, 2018 Three Months Ended September 30, 2017 
(dollars in thousands) Interest Income (Expense)  Other Income (Expense)  Interest Income (Expense)  Other Income (Expense) 
Total amounts of income and expense line items presented in the Consolidated Statements of Operations in which the effects of cash flow hedges are recorded $214  $—  $(307) $— 
                 
The effects of cash flow hedging:                
   Gain or (loss) on cash flow hedging relationships in Subtopic 815-20                
           Interest contracts                
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income $214  $—  $(307) $— 
  Location and Amount of Gain or (Loss) Recognized in Income on Fair Value
  and Cash Flow Hedging Relationships (in 000's)
  Three Months Ended June 30, Six Months Ended June 30,
  2019 2018 2019 2019 2018
  Interest Expense Interest Expense Gain on sale of investment securities Interest Expense
Total amounts of income and expense line items presented in the statement of financial performance in which the effects of fair value or cash flow hedges are recorded $313  $104  $775  $829  $16 
                     
Gain or (loss) on cash flow hedging relationships in Subtopic 815-20                    
Interest contracts                    
Amount of gain or (loss) reclassified from accumulated other  comprehensive income into income $313  $104  $775  $—    $16 
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income as a result that a forecasted transaction is no longer probable of occurring $—    $—    $—    $829  $—   

                 
  Location and Amount of Gain or (Loss) Recognized in Income on Cash Flow Hedging Relationships 
  Nine Months Ended September 30, 2018  Nine Months Ended September 30, 2017 
(dollars in thousands) Interest Income (Expense)  Other Income (Expense)  Interest Income (Expense)  Other Income (Expense) 
Total amounts of income and expense line items presented in the Consolidated Statements of Operations in which the effects of cash flow hedges are recorded $230  $—  $(1,321) $— 
                 
The effects of cash flow hedging:                
   Gain or (loss) on cash flow hedging relationships in Subtopic 815-20                
           Interest contracts                
Amount of gain or (loss) reclassified from accumulated other comprehensive income into income $230  $—  $(1,321) $— 

Effect of Derivatives Not Designated as Hedging Instruments on the Statement of Financial Performance 
Derivatives Not Designated as
Hedging Instruments under Subtopic
815-20		 Location of Gain or
(Loss) Recognized in
Income on Derivative		 Amount of Gain or (Loss)
Recognized in Income on
Derivative		  Amount of Gain or (Loss)
Recognized in Income on
Derivative		 
    Three Months Ended June 30,  Six Months Ended June 30, 
    2019  2018  2019  2018 
               
Other Contracts Other income / (expense)  (29)  —   (42)  — 
Total    (29)  —   (42)  — 

 27


Balance Sheet Offsetting: Our designated cash flow hedge interest rate swap derivatives are eligible for offset in the Consolidated Balance Sheets and are subject to master netting arrangements. Our derivative transactions with counterparties are generally executed under International Swaps and Derivative Association (“ISDA”) master agreements which include “right of set-off” provisions. In such cases there is generally a legally enforceable right to offset recognized amounts and there may be an intention to settle such amounts on a net basis. The Company generally offsets such financial instruments for financial reporting purposes. The table below presents a gross presentation, the effects of offsetting, and a net presentation of the Company’s cash flow hedge derivatives as of SeptemberJune 30, 20182019 and December 31, 2017.2018.

 

As of September 30, 2018
Offsetting of Derivative Assets(dollars in thousands)
              Gross Amounts Not Offset in the Balance Sheet 
  Gross Amounts of Recognized Assets  Gross Amounts Offset in the Balance Sheet  Net Amounts of Assets presented in the Balance Sheet  Financial Instruments  Cash Collateral Posted  Net Amount 
Counterparty 1 $5,220  $—  $5,220  $—  $—  $5,220 
Counterparty 2  1,270   —  $1,270   —   —  $1,270 
Counterparty 3  (29)  —  $(29)  —   —  $(29)
  $6,461  $—  $6,461  $—  $—  $6,461 

As of June 30, 2019
Offsetting of Derivative Assets(dollars in thousands)    Gross Amounts Not Offset in the Balance Sheet
  Gross Amounts of Recognized Assets  Gross Amounts Offset in the Balance Sheet  Net Amounts of Assets presented in the Balance Sheet  Financial Instruments Cash Collateral Posted  Net Amount 
Derivatives $41  $—  $41  $— $—  $41 

 

Offsetting of Derivative Liabilities(dollars in thousands)    Gross Amounts Not Offset in the Balance Sheet
  Gross Amounts of Recognized Liabilities  Gross Amounts Offset in the Balance Sheet  Net Amounts of Liabilities presented in the Balance Sheet  Financial Instruments Cash Collateral Posted  Net Amount 
Derivatives  $224  $—  $224  $— $—  $224 

As of December 31, 2017
Offsetting of Derivative Assets(dollars in thousands)
              Gross Amounts Not Offset in the Balance Sheet 
  Gross Amounts of Recognized Assets  Gross Amounts Offset in the Balance Sheet  Net Amounts of Assets presented in the Balance Sheet  Financial Instruments  Cash Collateral Posted  Net Amount 
Counterparty 1 $1,619  $—  $1,619  $—  $—  $1,619 
Counterparty 2  582   —   582   —   —   582 
  $2,201  $—  $2,201  $—  $—  $2,201 
                  
As of December 31, 2018
Offsetting of Derivative Assets(dollars in thousands)    Gross Amounts Not Offset in the Balance Sheet 
  Gross Amounts of Recognized Assets  Gross Amounts Offset in the Balance Sheet  Net Amounts of Assets presented in the Balance Sheet  Financial Instruments Cash Collateral Posted  Net Amount 
Derivatives  $3,840  $—  $3,840  $— $—  $3,840 

Offsetting of Derivative Liabilities(dollars in thousands)    Gross Amounts Not Offset in the Balance Sheet
  Gross Amounts of Recognized Liabilities  Gross Amounts Offset in the Balance Sheet  Net Amounts of Liabilities presented in the Balance Sheet  Financial Instruments Cash Collateral Posted  Net Amount 
Derivatives $59  $—  $59  $— $—  $59 

 

Note 7.9. Other Real Estate Owned

 

The activity within Other Real Estate Owned (“OREO”) for the three and ninesix months ended SeptemberJune 30, 20182019 and 20172018 is presented in the table below. There were nowas one residential real estate loansloan in the process of foreclosure as of SeptemberJune 30, 2018.2019 totaling $985 thousand. For the three and ninesix months ended SeptemberJune 30, 2019 and 2018, there were no sales of OREO property. For the three months ended September 30, 2017, proceeds on sale of OREO were $1.2 million from the sale of two OREO properties with a total carrying value of $1.1 million resulting in a net gain of $60 thousand. For the nine months ended September 30, 2017, proceeds on sale of OREO were $2.1 million from the sale of three OREO properties with a total carrying value of $2.5 million resulting in a net loss of $301 thousand.

 

  Three Months Ended September 30,  Nine Months Ended September 30, 
(dollars in thousands) 2018  2017  2018  2017 
             
Balance at January 1, $1,394  $1,394  $1,394  $2,694 
Real estate acquired from borrowers  —   1,145   —   1,145 
Properties sold  —   (1,145)  —   (2,445)
Ending balance $1,394  $1,394  $1,394  $1,394 

  Three Months Ended June 30,  Six Months Ended June 30, 
(dollars in thousands) 2019  2018  2019  2018 
Beginning Balance $1,394  $1,394  $1,394  $1,394 
Real estate acquired from borrowers  —   —   —   — 
Properties sold  —   —   —   — 
Ending Balance $1,394  $1,394  $1,394  $1,394 

 28


Note 8.10. Long-Term Borrowings

 

The following table presents information related to the Company’s long-term borrowings as of SeptemberJune 30, 20182019 and December 31, 2017.2018.

 

(dollars in thousands) September 30, 2018  December 31, 2017 
       
Subordinated Notes, 5.75% $70,000  $70,000 
Subordinated Notes, 5.0%  150,000   150,000 
Less: unamortized debt issuance costs  (2,802)  (3,095)
Long-term borrowings $217,198  $216,905 

(dollars in thousands) June 30,
2019		  December 31,
2018		 
Subordinated Notes, 5.75% $70,000  $70,000 
Subordinated Notes, 5.0%  150,000   150,000 
Less: unamortized debt issuance costs  (2,509)  (2,704)
Long-term borrowings $217,491  $217,296 

 

On August 5, 2014, the Company completed the sale of $70.0 million of its 5.75% subordinated notes, due September 1, 2024 (the “2024 Notes”). The 2024 Notes were offered to the public at par and qualify as Tier 2 capital for regulatory purposes to the fullest extent permitted under the Basel III Rule capital requirements. The net proceeds were approximately $68.8 million, which includes $1.2 million in deferred financing costs which are being amortized over the life of the 2024 Notes.

 

On July 26, 2016, the Company completed the sale of $150.0 million of its 5.00% Fixed-to-Floating Rate Subordinated Notes, due August 1, 2026 (the “2026 Notes”). The 2026 Notes were offered to the public at par and qualify as Tier 2 capital for regulatory purposes to the fullest extent permitted under the Basel III Rule capital requirements. The net proceeds were approximately $147.35 million, which includes $2.6 million in deferred financing costs which are being amortized over the life of the 2026 Notes.

 

Note 9.11. Net Income per Common Share

 

The calculation of net income per common share for the three and six months ended SeptemberJune 30, 20182019 and 20172018 was as follows.follows:

 

 Three Months Ended September 30,  Nine Months Ended September 30,  Three Months Ended June 30,  Six Months Ended June 30, 
(dollars and shares in thousands, except per share data) 2018  2017  2018  2017  2019  2018  2019  2018 
Basic:                  
Net income $38,948  $29,874  $111,959  $84,663  $37,243  $37,296  $70,992  $73,011 
Average common shares outstanding  34,309   34,174   34,292   34,124   34,540   34,306   34,511   34,283 
Basic net income per common share $1.14  $0.87  $3.26  $2.48  $1.08  $1.09  $2.06  $2.13 
                                
Diluted:                                
Net income $38,948  $29,874  $111,959  $84,663  $37,243  $37,296  $70,992  $73,011 
Average common shares outstanding  34,309   34,174   34,292   34,124   34,540   34,306   34,511   34,283 
Adjustment for common share equivalents  152   164   152   192   25   142   38   145 
Average common shares outstanding-diluted  34,461   34,338   34,444   34,316   34,565   34,448   34,549   34,428 
Diluted net income per common share $1.13  $0.87  $3.25  $2.47  $1.08  $1.08  $2.05  $2.12 
                                
Anti-dilutive shares  3   —   —   —   2   —   19   — 

Note 10.12. Other Comprehensive Income

 

The following table presents the components of other comprehensive income (loss) for the three and ninesix months ended SeptemberJune 30, 20182019 and 2017.2018.

 

(dollars in thousands) Before Tax  Tax Effect  Net of Tax 
          
Three Months Ended September 30, 2018            
Net unrealized loss on securities available-for-sale $(4,253) $1,105  $(3,148)
Less: Reclassification adjustment for net gains included in net income  —   —   — 
Total unrealized loss  (4,253)  1,105   (3,148)
             
Net unrealized gain on derivatives  846   221   625 
Less: Reclassification adjustment for losses included in net income  (211)  (53)  (158)
Total unrealized gain  635   168   467 
             
Other Comprehensive Loss $(3,618) $1,273  $(2,681)
             
Three Months Ended September 30, 2017            
Net unrealized gain on securities available-for-sale $25  $10  $15 
Less: Reclassification adjustment for net gains included in net income  (11)  (4)  (7)
Total unrealized gain  14   6   8 
             
Net unrealized loss on derivatives  557   210   347 
Less: Reclassification adjustment for losses included in net income  (289)  (106)  (183)
Total unrealized loss  268   104   164 
             
Other Comprehensive Income $282  $110  $172 
             
Nine Months Ended September 30, 2018            
Net unrealized gain on securities available-for-sale $(13,079) $2,873  $(10,206)
Less: Reclassification adjustment for net gains included in net income  (68)  (17)  (51)
Total unrealized loss  (13,147)  2,856   (10,257)
             
Net unrealized gain on derivatives  4,380   833   3,547 
Less: Reclassification adjustment for losses included in net income  (209)  (53)  (156)
Total unrealized gain  4,171   780   3,391 
             
Other Comprehensive Loss $(8,976) $3,636  $(6,866)
             
Nine Months Ended September 30, 2017            
Net unrealized gain on securities available-for-sale $2,080  $837  $1,243 
Less: Reclassification adjustment for net gains included in net income  (542)  (202)  (340)
Total unrealized gain  1,538   635   903 
             
Net unrealized gain on derivatives  2,186   836   1,350 
Less: Reclassification adjustment for losses included in net income  (1,308)  (487)  (821)
Total unrealized gain  878   349   529 
             
Other Comprehensive Income $2,416  $984  $1,432 

(dollars in thousands) Before Tax  Tax Effect  Net of Tax 
          
Three Months Ended June 30, 2019            
Net unrealized gain on securities available-for-sale $7,976  $2,051  $5,925 
Less: Reclassification adjustment for net gains included in net income  (563)  (146)  (417)
Total unrealized gain  7,413   1,905   5,508 
             
Net unrealized loss on derivatives  (171)  (342)   (513)
Less: Reclassification adjustment for gain included in net income  (319)  (83)  (236)
Total unrealized loss  (490)  259   (749)
             
Other Comprehensive Income $6,923  $2,164  $4,759 
             
Three Months Ended June 30, 2018            
Net unrealized loss on securities available-for-sale $(2,605) $670  $(1,935)
Less: Reclassification adjustment for net gains included in net income  (26)  (6)  (20)
Total unrealized loss  (2,631)  664   (1,955)
             
Net unrealized gain on derivatives  930   238   692 
Less: Reclassification adjustment for losses included in net income  87   23   64 
Total unrealized gain  1,017   261   756 
             
Other Comprehensive Loss $(1,614) $925  $(1,199)
             
Six Months Ended June 30, 2019            
Net unrealized gain on securities available-for-sale $16,127  $(4,148) $11,979 
Less: Reclassification adjustment for net gains included in net income  (1,475)  (383)  (1,092)
Total unrealized gain  14,652   (4,531)  10,887 
             
Net unrealized loss on derivatives  (2,234)  569   (1,665)
Less: Reclassification adjustment for gain included in net income  (1,594)  (414)  (1,180)
Total unrealized loss  (3,828)  155   (2,845)
             
Other Comprehensive Income $10,824  $(4,376) $8,042 
             
Six Months Ended June 30, 2018            
Net unrealized loss on securities available-for-sale $(8,826) $1,768  $(7,058)
Less: Reclassification adjustment for net gains included in net income  (68)  (17)  (51)
Total unrealized loss  (8,894)  1,751   (7,109)
             
Net unrealized gain on derivatives  3,537   612   2,925 
Less: Reclassification adjustment for losses included in net income  (1)  —   (1)
Total unrealized gain  3,536   612   2,924 
             
Other Comprehensive Loss $(5,358) $2,363  $(4,185)

The following table presents the changes in each component of accumulated other comprehensive loss,income (loss), net of tax, for the three and ninesix months ended SeptemberJune 30, 20182019 and 2017.2018.

 

(dollars in thousands) Securities Available For Sale  Derivatives  Accumulated Other
Comprehensive Income (Loss)		 
          
Three Months Ended September 30, 2018            
Balance at Beginning of Period $(10,914) $4,305  $(6,609)
Other comprehensive income (loss) before reclassifications  (3,148)  625   (2,523)
Amounts reclassified from accumulated other comprehensive income (loss)  —   (158)  (158)
Total other comprehensive income (loss)  (3,148)  467   (2,681)
Balance at End of Period $(14,062) $4,772  $(9,290)
             
Three Months Ended September 30, 2017            
Balance at Beginning of Period $(1,060) $(61) $(1,121)
Other comprehensive income before reclassifications  15   347   362 
Amounts reclassified from accumulated other comprehensive income  (7)  (183)  (190)
Net other comprehensive income during period  8   164   172 
Balance at End of Period $(1,052) $103  $(949)
             
Nine Months Ended September 30, 2018            
Balance at Beginning of Period $(3,131) $1,381  $(1,750)
Other comprehensive income (loss) before reclassifications  (10,206)  3,547   (6,659)
Amounts reclassified from accumulated other comprehensive income  (51)  (156)  (207)
Total other comprehensive income (loss)  (10,257)  3,391   (6,866)
Reclassification of the Income Tax Effects of the Tax Cuts and Jobs Act from AOCI  (674)  —   (674)
Balance at End of Period $(14,062) $4,772  $(9,290)
             
Nine Months Ended September 30, 2017            
Balance at Beginning of Period $(1,955) $(426) $(2,381)
Other comprehensive income before reclassifications  1,243   1,350   2,593 
Amounts reclassified from accumulated other comprehensive income  (340)  (821)  (1,161)
Net other comprehensive income during period  903   529   1,432 
Balance at End of Period $(1,052) $103  $(949)

(dollars in thousands) Securities Available For Sale  Derivatives  Accumulated Other Comprehensive Income (Loss) 
          
Three Months Ended June 30, 2019            
Balance at Beginning of Period $(1,665) $673  $(992)
Other comprehensive income (loss) before reclassifications  5,925   (513)  5,412 
Amounts reclassified from accumulated other comprehensive income  (417)  (236)  (653)
Net other comprehensive income (loss) during period  5,508   (749)  4,759 
Balance at End of Period $3,843  $(76) $3,767 
             
Three Months Ended June 30, 2018            
Balance at Beginning of Period $(8,959) $3,549  $(5,410)
Other comprehensive income (loss) before reclassifications  (1,935)  692   (1,243)
Amounts reclassified from accumulated other comprehensive income  (20)  64   44 
Net other comprehensive (loss) income during period  (1,955)  756   (1,199)
Balance at End of Period $(10,914) $4,305  $(6,609)

 

(dollars in thousands) Securities Available For Sale  Derivatives  Accumulated Other Comprehensive Income (Loss) 
Six Months Ended June 30, 2019            
Balance at Beginning of Period $(7,044) $2,769  $(4,275)
Other comprehensive income (loss) before reclassifications  11,979   (1,665)  10,314 
Amounts reclassified from accumulated other comprehensive income  (1,092)  (1,180)  (2,272)
Net other comprehensive income (loss) during period  10,887   (2,845)  8,042 
Balance at End of Period $3,843  $(76) $3,767 
             
Six Months Ended June 30, 2018            
Balance at Beginning of Period $(3,131) $1,381  $(1,750)
Other comprehensive income (loss) before reclassifications  (7,058)  2,925   (4,133)
Amounts reclassified from accumulated other comprehensive income  (51)  (1)  (52)
Net other comprehensive (loss) income during period  (7,109)  2,924   (4,185)
Reclassification of the Income Tax Effects of the Tax Cuts and Jobs Act from AOCI  (674)  —   (674)
Balance at End of Period $(10,914) $4,305  $(6,609)

The following table presents the amounts reclassified out of each component of accumulated other comprehensive income (loss) income for the three and ninesix months ended SeptemberJune 30, 20182019 and 2017.2018.

 

Details about Accumulated Other Amount Reclassified from  Affected Line Item in
Comprehensive Income Components Accumulated Other  the Statement Where
(dollars in thousands) Comprehensive (Loss) Income  Net Income is Presented
  Three Months Ended September 30,   
  2018  2017   
Realized gain on sale of investment securities $—  $(11) Gain on sale of investment securities
Interest expense derivative deposits  (211)  (289) Interest expense on deposits
Income tax benefit (expense)  53   110  Tax expense
Total Reclassifications for the Period $(158) $(190) Net Income

           
Details about Accumulated Other Amount Reclassified from  Affected Line Item in
Comprehensive Income Components Accumulated Other  the Statement Where
(dollars in thousands) Comprehensive (Loss) Income  Net Income is Presented
  Nine Months Ended September 30,   
   2018   2017   
Realized gain on sale of investment securities $(68) $(542) Gain on sale of investment securities
Interest expense derivative deposits  (209)  (1,308) Interest expense on deposits
Income tax benefit (expense)  70   689  Tax expense
Total Reclassifications for the Period $(207) $(1,161) Net Income
Details about Accumulated Other
Comprehensive Income Components
(dollars in thousands)		 Amount Reclassified from
Accumulated Other
Comprehensive Income (Loss)		  Affected Line Item in
the Statement Where
Net Income is Presented
  Three Months Ended June 30,   
  2019  2018   
Realized gain on sale of investment securities $563  $26  Gain on sale of investment securities
Interest income (expense) derivative deposits  319   (87) Interest expense on deposits
Income tax (expense) benefit  (229)  17  Income Tax Expense
Total Reclassifications for the Period $653  $(44) Net Income

 


Details about Accumulated Other
Comprehensive Income Components
(dollars in thousands)		 Amount Reclassified from
Accumulated Other
Comprehensive Income		  Affected Line Item in
the Statement Where
Net Income is Presented
  Six Months Ended June 30,   
  2019  2018   
Realized gain on sale of investment securities $1,475  $68  Gain on sale of investment securities
Realized gain on swap termination  829   —  Gain on sale of investment securities
Interest income (expense) derivative deposits  765   1  Interest expense on deposits
Income tax expense  (797)  (17) Income Tax Expense
Total Reclassifications for the Period $2,272  $52  Net Income

Note 11.13. Fair Value Measurements

 

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 820,“Fair Value Measurements and Disclosures,” establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

 

Level 1Quoted prices in active exchange markets for identical assets or liabilities; also includes certain U.S. Treasury and other U.S. Government and agency securities actively traded in over-the-counter markets.

 

Level 2Observable inputs other than Level 1 including quoted prices for similar assets or liabilities, quoted prices in less active markets, or other observable inputs that can be corroborated by observable market data; also includes derivative contracts whose value is determined using a pricing model with observable market inputs or can be derived principally from or corroborated by observable market data. This category generally includes certain U.S. Government and agency securities, corporate debt securities, derivative instruments, and residential mortgage loans held for sale.

 

Level 3Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation; also includes observable inputs for single dealer nonbinding quotes not corroborated by observable market data. This category generally includes certain private equity investments, retained interests from securitizations, and certain collateralized debt obligations.

Assets and Liabilities Recorded at Fair Value on a Recurring Basis

 

The table below presents the recorded amount of assets and liabilities measured at fair value on a recurring basis as of SeptemberJune 30, 20182019 and December 31, 2017.2018.

(dollars in thousands) Quoted Prices (Level 1)  Significant Other Observable Inputs
(Level 2)		  Significant Other Unobservable Inputs
(Level 3)		  Total
(Fair Value)		 
June 30, 2019        
Assets:        
Investment securities available-for-sale:                
U. S. agency securities $—    $225,670  $—    $225,670 
Residential mortgage backed securities  —     443,545   —     443,545 
Municipal bonds  —     69,338   —     69,338 
Corporate bonds  —     —     6,572   6,572 
Other equity investments  —     —     218   218 
Loans held for sale  —     37,506   —     37,506 
Interest Rate Caps  —     41   —     41 
Mortgage banking derivatives  —     —     387   387 
Total assets measured at fair value on a recurring basis as of June 30, 2019 $—    $776,100  $7,177  $783,277 
                 
Liabilities:                
Interest rate swap derivatives $—    $101  $—    $101 
Derivative liability  —     101   —     101 
Interest Rate Caps  —     40   —     40 
Mortgage banking derivatives  —     —     309   309 
Total liabilities measured at fair value on a recurring basis as of June 30, 2019 $—    $242  $309  $551 
                 
December 31, 2018                
Assets:                
Investment securities available-for-sale:                
U. S. agency securities $—    $256,345  $—    $256,345 
Residential mortgage backed securities  —     472,231   —     472,231 
Municipal bonds  —     45,769   —     45,769 
Corporate bonds  —     —     9,576   9,576 
Other equity investments  —     —     218   218 
Loans held for sale  —     19,254   —     19,254 
Mortgage banking derivatives  —     —     229   229 
Interest rate swap derivatives  —     3,727   —     3,727 
Total assets measured at fair value on a recurring basis as of December 31, 2018 $—    $797,326  $10,023  $807,349 
                 
Liabilities:                
Mortgage banking derivatives $—    $—    $269  $269 
Total liabilities measured at fair value on a recurring basis as of December 31, 2018 $—    $—    $269  $269 

 

(dollars in thousands) Quoted Prices
(Level 1)		  Significant Other
Observable Inputs
(Level 2)		  Significant Other
Unobservable
Inputs (Level 3)		  Total
(Fair Value)		 
September 30, 2018                
Assets:                
Investment securities available for sale:                
U. S. agency securities $—  $230,325  $—  $230,325 
Residential mortgage backed securities  —   436,349   —   436,349 
Municipal bonds  —   47,736   —   47,736 
Corporate bonds  —   6,546   1,500   8,046 
Other equity investments  —   —   218   218 
Loans held for sale  —   18,728   —   18,728 
Mortgage banking derivatives  —   —   80   80 
Interest rate swap derivatives  —   6,427   —   6,427 
Total assets measured at fair value on a recurring basis as of September 30, 2018 $—  $746,111  $1,798  $747,909 
Liabilities:                
Mortgage banking derivatives $—  $—  $28  $28 
Total liabilities measured at fair value on a recurring basis as of September 30, 2018 $—  $—  $28  $28 
December 31, 2017                
Assets:                
Investment securities available for sale:                
U. S. agency securities $—  $195,984  $—  $195,984 
Residential mortgage backed securities  —   317,836   —   317,836 
Municipal bonds  —   62,057   —   62,057 
Corporate bonds  —   11,673   1,500   13,173 
Other equity investments  —   —   218   218 
Loans held for sale  —   25,096   —   25,096 
Mortgage banking derivatives  —   —   43   43 
Interest rate swap derivatives  —   2,256   —   2,256 
Total assets measured at fair value on a recurring basis as of December 31, 2017 $—  $614,902  $1,761  $616,663 
Liabilities:                
Mortgage banking derivatives $—  $—  $10  $10 
Total liabilities measured at fair value on a recurring basis as of December 31, 2017 $—  $—  $10  $10 

 

Investment Securities Available-for-Sale:Investment securities available-for-sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange such as the New York Stock Exchange, Treasury securities that are traded by dealers or brokers in active over-the-counter markets and money market funds. Level 2 securities include U.S. agency debt securities, mortgage backed securities issued by Government Sponsored Entities (“GSE’s”) and municipal bonds. Securities classified as Level 3 include securities in less liquid markets, the carrying amounts approximate the fair value.

 

Loans held for sale: The Company has elected to carry loans held for sale at fair value. This election reduces certain timing differences in the Consolidated Statement of Operations and better aligns with the management of the portfolio from a business perspective. Fair value is derived from secondary market quotations for similar instruments. Gains and losses on sales of residential mortgage loans are recorded as a component of noninterest income in the Consolidated Statements of Operations. Gains and losses on sales of multifamily FHA securities are recorded as a component of noninterest income in the Consolidated Statements of Operations. As such, the Company classifies loans subjected to fair value adjustments as Level 2 valuation.


The following table summarizes the difference between the aggregate fair value and the aggregate unpaid principal balance for loans held for sale measured at fair value as of SeptemberJune 30, 20182019 and December 31, 2017.2018.

 

  June 30, 2019 
(dollars in thousands) Fair Value  Aggregate Unpaid Principal Balance  Difference 
          
Residential mortgage loans held for sale $37,506  $36,638  $868 
FHA mortgage loans held for sale $—  $—  $— 

  September 30, 2018 
     Aggregate Unpaid    
(dollars in thousands) Fair Value Principal Balance Difference 
           
Residential mortgage loans held for sale $18,728 $18,488 $240 
FHA mortgage loans held for sale $— $— $— 

          
 December 31, 2017 
    Aggregate Unpaid     December 31, 2018 
(dollars in thousands) Fair Value Principal Balance Difference  Fair Value  Aggregate Unpaid Principal Balance  Difference 
                 
Residential mortgage loans held for sale $25,096 $24,674 $422  $19,254  $18,797  $457 
FHA mortgage loans held for sale $— $— $—  $—  $—  $— 

 

No residential mortgage loans held for sale were 90 or more days past due or on nonaccrual status as of SeptemberJune 30, 20182019 or December 31, 2017.2018.

 

Interest rate swap derivatives:These derivative instruments consist of forward starting interest rate swap agreements, which are accounted for as cash flow hedges under ASC 815. The Company’s derivative position is classified within Level 2 of the fair value hierarchy and is valued using models generally accepted in the financial services industry and that use actively quoted or observable market input values from external market data providers and/or non-binding broker-dealer quotations. The fair value of the derivatives is determined using discounted cash flow models. These models’ key assumptions include the contractual terms of the respective contract along with significant observable inputs, including interest rates, yield curves, nonperformance risk and volatility. Derivative contracts are executed with a Credit Support Annex, which is a bilateral agreement that requires collateral postings when the market value exceeds certain threshold limits. These agreements protect the interests of the Company and its counterparties should either party suffer a credit rating deterioration.

 

Credit Risk Participation Agreements: The Company enters into credit risk participation agreements (“RPAs”) with institutional counterparties, under which the Company assumes its pro-rata share of the credit exposure associated with a borrower’s performance related to interest rate derivative contracts. The fair value of RPAs is calculated by determining the total expected asset or liability exposure of the derivatives to the borrowers and applying the borrowers’ credit spread to that exposure. Total expected exposure incorporates both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities. Accordingly, RPAs fall within Level 2.

 

Interest Rate Caps: the Company entered into an interest rate cap agreement (“cap”) with an institutional counterparty, under which the Company will receive cash if and when market rates exceed the cap’s strike rate. The fair value of the cap is calculated by determining the total expected asset or liability exposure of the derivatives. Total expected exposure incorporates both the current and potential future exposure of the derivative, derived from using observable inputs, such as yield curves and volatilities. Accordingly, the cap falls within Level 2.

Mortgage banking derivatives:The Company relies on a third-party pricing service to value its mortgage banking derivative financial assets and liabilities, which the Company classifies as a Level 3 valuation. The external valuation model to estimate the fair value of its interest rate lock commitments to originate residential mortgage loans held for sale includes grouping the interest rate lock commitments by interest rate and terms, applying an estimated pull-through rate based on historical experience, and then multiplying by quoted investor prices determined to be reasonably applicable to the loan commitment groups based on interest rate, terms, and rate lock expiration dates of the loan commitment groups. The Company also relies on an external valuation model to estimate the fair value of its forward commitments to sell residential mortgage loans (i.e., an estimate of what the Company would receive or pay to terminate the forward delivery contract based on market prices for similar financial instruments), which includes matching specific terms and maturities of the forward commitments against applicable investor pricing.


The following is a reconciliation of activity for assets and liabilities measured at fair value based on Significant Other Unobservable Inputs (Level 3):

 

(dollars in thousands) Investment Securities  Mortgage Banking Derivatives  Total 
Assets:            
Beginning balance at January 1, 2019 $9,794  $229  $10,023 
Realized gain included in earnings  —   158   158 
Unrealized loss included in other comprehensive income  —   —   — 
Principal redemption  (3,004)  —   (3,004)
Ending balance at June 30, 2019 $6,790  $387  $7,177 
             
Liabilities:            
Beginning balance at January 1, 2019 $—  $269  $269 
Realized gain included in earnings  —   40   40 
Principal redemption  —   —   — 
Ending balance at June 30, 2019 $—  $309  $309 

  Investment  Mortgage Banking    
(dollars in thousands) Securities  Derivatives  Total 
Assets:            
Beginning balance at January 1, 2018 $1,718  $43  $1,761 
Realized gain included in earnings - net mortgage banking derivatives  —   37   37 
    Purchases of available-for-sale securities  —   —   — 
    Principal redemption  —   —   — 
Ending balance at September 30, 2018 $1,718  $80  $1,798 
             
Liabilities:            
Beginning balance at January 1, 2018 $—  $10  $10 
Realized loss included in earnings - net mortgage banking derivatives  —   18   18 
    Principal redemption  —   —   — 
Ending balance at September 30, 2018 $—  $28  $28 

             
  Investment  Mortgage Banking     
(dollars in thousands) Securities  Derivatives  Total 
Assets:            
Beginning balance at January 1, 2017 $1,718  $114  $1,832 
Realized loss included in earnings - net mortgage banking derivatives  —   (71)  (71)
    Purchases of available-for-sale securities  —   —   — 
    Principal redemption  —   —   — 
Ending balance at December 31, 2017 $1,718  $43  $1,761 
             
Liabilities:            
Beginning balance at January 1, 2017 $—  $55  $55 
Realized loss included in earnings - net mortgage banking derivatives  —   (45)  (45)
    Principal redemption  —   —   — 
Ending balance at December 31, 2017 $—  $10  $10 

(dollars in thousands) Investment Securities  Mortgage Banking Derivatives  Total 
Assets:            
Beginning balance at January 1, 2018 $1,718  $43  $1,761 
Realized gain included in earnings  —   186   186 
Purchases of available-for-sale securities  8,076   —   8,076 
Principal redemption  —   —   — 
Ending balance at December 31, 2018 $9,794  $229  $10,023 
             
Liabilities:            
Beginning balance at January 1, 2018 $—  $10  $10 
Realized loss included in earnings  —   259   259 
Principal redemption  —   —   — 
Ending balance at December 31, 2018 $—  $269  $269 

 

The other equity securities classified as Level 3 consist of equity investments in the form of common stock of two local banking companies which are not publicly traded, and for which the carrying amount approximates fair value.

 

Assets and Liabilities Recorded at Fair Value on a Nonrecurring Basis

 

The Company measures certain assets at fair value on a nonrecurring basis and the following is a general description of the methods used to value such assets.

 

Impaired loans: The Company does not record loans at fair value on a recurring basis; however, from time to time, a loan is considered impaired and an allowance for loan loss is established. The Company considers a loan impaired when it is probable that the Company will be unable to collect all amounts due according to the original contractual terms of the note agreement, including both principal and interest. Management has determined that nonaccrual loans and loans that have had their terms restructured in a troubled debt restructuring meet this impaired loan definition. Once a loan is identified as individually impaired, management measures impairment in accordance with ASC Topic 310,“Receivables.” The fair value of impaired loans is estimated using one of several methods, including the collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring a specific allowance represent loans for which the fair value of expected repayments or collateral exceed the recorded investment in such loans. At SeptemberJune 30, 2018,2019, substantially all of the Company’s impaired loans were evaluated based upon the fair value of the collateral. In accordance with ASC Topic 820, impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the loan as nonrecurring Level 3. For individually evaluated impaired loans, the amount of impairment is based upon the present value of expected future cash flows discounted at the loan’s effective interest rate or the estimated fair value of the underlying collateral for collateral-dependent loans, which the Company classifies as a Level 3 valuation.


Other real estate owned: Other real estate owned is initially recorded at fair value less estimated selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral, which the Company classifies as a Level 3 valuation. Assets measured at fair value on a nonrecurring basis are included in the table below:

 

(dollars in thousands) Quoted Prices (Level 1)  Significant Other Observable Inputs
(Level 2)		  Significant Other
Unobservable Inputs
(Level 3)		  Total
(Fair Value)		 
June 30, 2019                
Impaired loans:                
Commercial $—  $—  $9,057  $9,057 
Income producing - commercial real estate  —   —   7,953   7,953 
Owner occupied - commercial real estate  —   —   4,344   4,344 
Real estate mortgage - residential  —   —   4,990   4,990 
Construction - commercial and residential  —   —   9,155   9,155 
Home equity  —   —   487   487 
Other real estate owned  —   —   1,394   1,394 
Total assets measured at fair value on a nonrecurring basis as of June 30, 2019 $—  $—  $37,380  $37,380 

(dollars in thousands) Quoted Prices
(Level 1)		  Significant Other
Observable Inputs
(Level 2)		  Significant Other
Unobservable
Inputs (Level 3)		  Total
(Fair Value)		 
September 30, 2018                
Impaired loans:                
Commercial $—  $—  $6,200  $6,200 
Income producing - commercial real estate  —   —   6,217   6,217 
Owner occupied - commercial real estate  —   —   5,261   5,261 
Real estate mortgage - residential  —   —   1,522   1,522 
Construction - commercial and residential          3,030   3,030 
Home equity  —   —   487   487 
Other consumer  —   —   36   36 
Other real estate owned  —   —   1,394   1,394 
Total assets measured at fair value on  a nonrecurring basis as of September 30, 2018 $—  $—  $24,147  $24,147 

                 
(dollars in thousands) Quoted Prices
(Level 1)		  Significant Other
Observable Inputs
(Level 2)		  Significant Other
Unobservable
Inputs (Level 3)		  Total
(Fair Value)		 
December 31, 2017                
Impaired loans:                
Commercial $—  $—  $2,266  $2,266 
Income producing - commercial real estate  —   —   7,664   7,664 
Owner occupied - commercial real estate  —   —   5,214   5,214 
Real estate mortgage - residential  —   —   775   775 
Construction - commercial and residential  —   —   1,552   1,552 
Home equity  —   —   494   494 
Other consumer  —   —   11   11 
Other real estate owned  —   —   1,394   1,394 
Total assets measured at fair value on a nonrecurring basis as of December 31, 2017 $—  $—  $19,370  $19,370 

(dollars in thousands) Quoted Prices (Level 1)  Significant Other Observable Inputs
(Level 2)		  Significant Other Unobservable Inputs
(Level 3)		  Total
(Fair Value)		 
December 31, 2018                
Impaired loans:                
Commercial $—  $—  $3,338  $3,338 
Income producing - commercial real estate  —   —   18,937   18,937 
Owner occupied - commercial real estate  —   —   5,131   5,131 
Real estate mortgage - residential  —   —   1,510   1,510 
Construction - commercial and residential  —   —   1,981   1,981 
Home equity  —   —   487   487 
Other real estate owned  —   —   1,394   1,394 
Total assets measured at fair value on a nonrecurring basis as of December 31, 2018 $—  $—  $32,778  $32,778 

 

Fair Value of Financial Instruments

 

The Company discloses fair value information about financial instruments for which it is practicable to estimate the value, whether or not such financial instruments are recognized on the balance sheet. Fair value is the amount at which a financial instrument could be exchanged in a current transaction between willing parties, other than in a forced sale or liquidation, and is best evidenced by quoted market price, if one exists.

 

Quoted market prices, if available, are shown as estimates of fair value. Because no quoted market prices exist for a portion of the Company’s financial instruments, the fair value of such instruments has been derived based on management’s assumptions with respect to future economic conditions, the amount and timing of future cash flows and estimated discount rates. Different assumptions could significantly affect these estimates. Accordingly, the net realizable value could be materially different from the estimates presented below. In addition, the estimates are only indicative of individual financial instrument values and should not be considered an indication of the fair value of the Company taken as a whole.


The following methods and assumptions were used to estimate the fair value of each category of financial instrument for which it is practicable to estimate value:

Cash due from banks and federal funds sold: For cash and due from banks and federal funds sold the carrying amount approximates fair value.

Interest bearing deposits with other banks: For interest bearing deposits with other banks the carrying amount approximates fair value.

Investment securities: For these instruments, fair values are based upon quoted prices, if available. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions.

Federal Reserve and Federal Home Loan Bank stock: The carrying amounts approximate the fair values at the reporting date.

Loans held for sale: As the Company has elected the fair value option, the fair value of loans held for sale is the carrying value and is based on commitments outstanding from investors as well as what secondary markets are currently offering for portfolios with similar characteristics for residential mortgage loans held for sale since such loans are typically committed to be sold (servicing released) at a profit. The fair value of multifamily FHA loans held for sale is the carrying value and is based on commitments outstanding from investors as well as what secondary markets are currently offering for portfolios with similar characteristics for multifamily FHA loans held for sale since such loans are typically committed to be securitized and sold (servicing retained) at a profit.

Loans:The loan portfolio is valued using an exit price notion. The present value of cash flows projection is established for each loan in the portfolio projecting contractual payments, default adjusted payments, cash flows in the event of default (including deferred timing of recoveries), and pre-payments. These expected cash flows are then discounted to present value using the note interest rate and an established market rate which, if different from the note rate, allows the Bank to isolate the amount above or below par a potential acquirer would pay to acquire the Bank’s portfolio.

Bank owned life insurance: The fair value of bank owned life insurance is the current cash surrender value, which is the carrying value.

Annuity investment:The fair value of the annuity investments is the carrying amount at the reporting date.

Mortgage banking derivatives:The Company enters into interest rate lock commitments with prospective residential mortgage borrowers. These commitments are carried at fair value based on the fair value of the underlying mortgage loans which are based on market data. These commitments are classified as Level 3 in the fair value disclosures, as the valuations are based on market unobservable inputs. The Company hedges the risk of the overall change in the fair value of loan commitments to borrowers by selling forward contracts on securities of GSEs. These forward settling contracts are classified as Level 3, as valuations are based on market unobservable inputs. See Note 4 to the Consolidated Financial Statements for additional detail.

Credit Risk Participation Agreements: The Company enters into credit risk participation agreements (“RPAs”) with institutional counterparties, under which the Company assumes its pro-rata share of the credit exposure associated with a borrower’s performance related to interest rate derivative contracts. The fair value of RPAs is calculated by determining the total expected asset or liability exposure of the derivatives to the borrowers and applying the borrowers’ credit spread to that exposure. Total expected exposure incorporates both the current and potential future exposure of the derivatives, derived from using observable inputs, such as yield curves and volatilities. Accordingly, RPAs fall within Level 2.


Interest rate swap derivatives:These derivative instruments consist of forward starting interest rate swap agreements, which are accounted for as cash flow hedges. The Company’s derivative position is classified within Level 2 of the fair value hierarchy and is valued using models generally accepted in the financial services industry and that use actively quoted or observable market input values from external market data providers and/or non-binding broker-dealer quotations. The fair value of the derivatives is determined using discounted cash flow models. These models’ key assumptions include the contractual terms of the respective contract along with significant observable inputs, including interest rates, yield curves, nonperformance risk and volatility. Derivative contracts are executed with a Credit Support Annex, which is a bilateral ratings-sensitive agreement that requires collateral postings when the market value exceeds certain threshold limits. These agreements protect the interests of the Company and its counterparties should either party suffer a credit rating deterioration.

Noninterest bearing deposits: The fair value of these deposits is the amount payable on demand at the reporting date, since generally accepted accounting standards do not permit an assumption of core deposit value.

Interest bearing deposits:The fair value of interest bearing transaction, savings, and money market deposits with no defined maturity is the amount payable on demand at the reporting date, since generally accepted accounting standards do not permit an assumption of core deposit value.

Certificates of deposit: The fair value of certificates of deposit is estimated by discounting the future cash flows using the current rates at which similar deposits with remaining maturities would be accepted.

Customer repurchase agreements: The carrying amount approximate the fair values at the reporting date.

Borrowings: The carrying amount for variable rate borrowings approximate the fair values at the reporting date. The fair value of fixed rate FHLB advances and the subordinated notes are estimated by computing the discounted value of contractual cash flows payable at current interest rates for obligations with similar remaining terms. The fair value of variable rate FHLB advances is estimated to be carrying value since these liabilities are based on a spread to a current pricing index.

Off-balance sheet items: Management has reviewed the unfunded portion of commitments to extend credit, as well as standby and other letters of credit, and has determined that the fair value of such instruments is equal to the fee, if any, collected and unamortized for the commitment made.


The estimated fair valuesvalue of the Company’s financial instruments at SeptemberJune 30, 20182019 and December 31, 20172018 are as follows:

 

      Fair Value Measurements       Fair Value Measurements 
(dollars in thousands) Carrying Value  Fair Value  

Quoted
Prices

(Level 1)

  

Significant
Other
Observable
Inputs

(Level 2)

  

Significant 
Unobservable
Inputs

(Level 3)

  Carrying Value  Fair Value  Quoted Prices (Level 1)  Significant Other Observable Inputs
(Level 2)		  Significant Unobservable Inputs
(Level 3)		 
September 30, 2018                    
June 30, 2019                    
Assets                                        
Cash and due from banks $4,459  $4,459  $—  $4,459  $—  $6,735  $6,735  $—    $6,735  $—   
Federal funds sold  17,284   17,284   —   17,284   —   17,914   17,914   —     17,914   —   
Interest bearing deposits with other banks  162,734   162,734   —   162,734   —   171,985   171,985   —     171,985   —   
Investment securities  722,674   722,674   —   720,956   1,718   745,343   745,343   —     738,553   6,790 
Federal Reserve and Federal Home Loan Bank stock  37,257   37,257   —   37,257   —   33,903   33,903   —     33,903   —   
Loans held for sale  18,728   18,728   —   18,728   —   37,506   37,506   —     37,506   —   
Loans(1)  6,776,483   6,713,861   —   —   6,713,861 
Loans  7,320,529   7,392,664   —     —     7,392,664 
Bank owned life insurance  74,295   74,295   —     74,295   —   
Annuity investment  12,088   12,088   —     12,088   —   
Interest Rate Caps  41   41   —     41   —   
Mortgage banking derivatives  387   387   —     —     387 
                    
Liabilities                    
Noninterest bearing deposits  1,873,902   1,873,902   —     1,873,902   —   
Interest bearing deposits  3,574,696   3,574,696   —     3,574,696   —   
Certificates of deposit  1,501,294   1,509,812   —     1,509,812   —   
Customer repurchase agreements  31,669   31,669   —     31,669   —   
Borrowings  467,491   468,790   —     468,790   —   
Interest rate swap derivatives  101   101       101   —   
Derivative liability  101   101   —     101   —   
Interest Rate Caps  40   40   —     40   —   
Mortgage banking derivatives  309   309   —     —     309 
                    
December 31, 2018                    
Assets                    
Cash and due from banks $6,773  $6,773  $—    $6,773  $—   
Federal funds sold  11,934   11,934   —     11,934   —   
Interest bearing deposits with other banks  303,157   303,157   —     303,157   —   
Investment securities  784,139   784,139   —     774,345   9,794 
Federal Reserve and Federal Home Loan Bank stock  23,506   23,506   —     23,506   —   
Loans held for sale  19,254   19,254   —     19,254   —   
Loans  6,921,503   6,921,048   —     —     6,921,048 
Bank owned life insurance  73,007   73,007   —   73,007   —   73,441   73,441   —     73,441   —   
Annuity investment  12,375   12,375   —   12,375   —   12,417   12,417   —     12,417   —   
Mortgage banking derivatives  80   80   —   —   80   229   229   —     —     229 
Interst rate swap derivatives  6,427   6,427   —   6,427   — 
Interest rate swap derivatives  3,727   3,727   —     3,727   —   
                                        
Liabilities                                        
Noninterest bearing deposits  2,057,886   2,057,886   —   2,057,886   —   2,104,220   2,104,220   —     2,104,220   —   
Interest bearing deposits  3,032,713   3,032,713   —   3,032,713   —   3,542,666   3,542,666   —     3,542,666   —   
Certificates of deposit  1,281,706   1,279,407   —   1,279,407   —   1,327,400   1,325,209   —     1,325,209   —   
Customer repurchase agreements  36,446   36,446   —   36,446   —   30,413   30,413   —     30,413   —   
Borrowings  542,198   533,304   —   533,304   —   217,196   218,006   —     218,006   —   
Mortgage banking derivatives  28   28   —   —   28   269   269   —     —     269 
                    
December 31, 2017                    
Assets                    
Cash and due from banks $7,445  $7,445  $—  $7,445  $— 
Federal funds sold  15,767   15,767   —   15,767   — 
Interest bearing deposits with other banks  167,261   167,261   —   167,261   — 
Investment securities  589,268   589,268   —   587,550   1,718 
Federal Reserve and Federal Home Loan Bank stock  36,324   36,324   —   36,324   — 
Loans held for sale  25,096   25,096   —   25,096   — 
Loans(2)  6,346,770   6,381,213   —   —   6,381,213 
Bank owned life insurance  60,947   60,947   —   60,947   — 
Annuity investment  11,632   11,632   —   11,632   — 
Mortgage banking derivatives  43   43   —   —   43 
Interst rate swap derivatives  2,256   2,256   —   2,256   — 
                    
Liabilities                    
Noninterest bearing deposits  1,982,912   1,982,912   —   1,982,912   — 
Interest bearing deposits  3,041,563   3,041,563   —   3,041,563   — 
Certificates of deposit  829,509   829,886   —   829,886   — 
Customer repurchase agreements  76,561   76,561   —   76,561   — 
Borrowings  541,905   533,162   —   533,162   — 
Mortgage banking derivatives  10   10   —   —   10 

 

(1)Carrying amount is net of unearned income and the allowance for credit losses. In accordance with the prospective adoption of ASU No. 2016-01, the fair value of loans was measured using an exit price notion.
(2)Carrying amount is net of unearned income and the allowance for credit losses. The fair value of loans was measured using an entry price notion.

Note 12.14. Supplemental Executive Retirement Plan

 

The Bank has entered into Supplemental Executive Retirement and Death Benefit Agreements (the “SERP Agreements”) with certain of the Bank’s executive officers, other than Mr. Paul, which upon the executive’s retirement, will provide for a stated monthly payment for such executive’s lifetime subject to certain death benefits described below. The retirement benefit is computed as a percentage of each executive’s projected average base salary over the five years preceding retirement, assuming retirement at age 67. The SERP Agreements provide that (a) the benefits vest ratably over six years of service to the Bank, with the executive receiving credit for years of service prior to entering into the SERP Agreement, (b) death, disability and change-in-control shall result in immediate vesting, and (c) the monthly amount will be reduced if retirement occurs earlier than age 67 for any reason other than death, disability or change-in-control. The SERP Agreements further provide for a death benefit in the event the retired executive dies prior to receiving 180 monthly installments, paid either in a lump sum payment or continued monthly installment payments, such that the executive’s beneficiary has received payment(s) sufficient to equate to a cumulative 180 monthly installments.

 

The SERP Agreements are unfunded arrangements maintained primarily to provide supplemental retirement benefits and comply with Section 409A of the Internal Revenue Code. The Bank financed the retirement benefits by purchasing fixed annuity contracts with four insurance carriers in 2013 totaling $11.4 million that have been designed to provide a future source of funds for the lifetime retirement benefits of the SERP Agreements. The primary impetus for utilizing fixed annuities is a substantial savings in compensation expenses for the Bank as opposed to a traditional SERP Agreement. For the three and six months ended SeptemberJune 30, 2018 and 2017,2019, the annuity contracts accrued $56$40 thousand of income offset by annual fees of $141 thousand, and $54$81 thousand of income offset by $150 thousand of annual fees, respectively, which were included in other noninterest income on the Consolidated Statement of Operations. For the three and six months ended June 30, 2018, the annuity contracts accrued $65 thousand of income offset by $110 thousand of annual fees, and $102 thousand of income offset by $119 thousand of annual fees, respectively, which were included in other noninterest income on the Consolidated Statement of Operations. The cash surrender value of the annuity contracts was $12.1 million and $12.4 million and $11.6 million at SeptemberJune 30, 20182019 and December 31, 2017,2018, respectively, and is included in other assets on the Consolidated Balance Sheet. For the three and ninesix months ended SeptemberJune 30, 2018,2019, the Company recorded benefit expense accruals of $100$101 thousand and $586$202 thousand, respectively, for this post retirement benefit. For the three and ninesix months ended SeptemberJune 30, 2017,2018, the Company recorded benefit expense accruals of $103$385 thousand and $308$486 thousand, respectively, for this post retirement benefit.

 

Upon death of a named executive, the annuity contract related to such executive terminates. The Bank has purchased additional bank owned life insurance contracts, which would effectively finance payments (up to a 15 year certain amount) to the executives’ named beneficiaries.

 

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion provides information about the results of operations, and financial condition, liquidity, and capital resources of the Company and its subsidiaries as of the dates and periods indicated. This discussion and analysis should be read in conjunction with the unaudited Consolidated Financial Statements and Notes thereto, appearing elsewhere in this report and the Management Discussion and Analysis in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.2018.

 

This report contains forward looking statements within the meaning of the Securities Exchange Act of 1934, as amended, including statements of goals, intentions, and expectations as to future trends, plans, events or results of Company operations and policies and regarding general economic conditions. In some cases, forward- looking statements can be identified by use of such words as “may,” “will,” “anticipate,” “believes,” “expects,” “plans,” “estimates,” “potential,” “continue,” “should,” and similar words or phrases. These statements are based upon current and anticipated economic conditions, nationally and in the Company’s market, interest rates and interest rate policy, competitive factors and other conditions, which by their nature are not susceptible to accurate forecast, and are subject to significant uncertainty. For details on factors that could affect these expectations, see the risk factors and other cautionary language included in the Company’s Annual Report on Form 10-K for the year ended December 31, 20172018 and in other periodic and current reports filed by the Company with the Securities and Exchange Commission. Because of these uncertainties and the assumptions on which this discussion and the forward-looking statements are based, actual future operations and results in the future may differ materially from those indicated herein. Readers are cautioned against placing undue reliance on any such forward looking statements.


GENERAL

 

The Company is a growth-oriented, one-bank holding company headquartered in Bethesda, Maryland, which is currently celebrating twentytwenty-one years of successful operations. The Company provides general commercial and consumer banking services through the Bank, its wholly owned banking subsidiary, a Maryland chartered bank which is a member of the Federal Reserve System. The Company was organized in October 1997, to be the holding company for the Bank. The Bank was organized in 1998 as an independent, community oriented, full service banking alternative to the super regional financial institutions, which dominate the Company’s primary market area. The Company’s philosophy is to provide superior, personalized service to its customers. The Company focuses on relationship banking, providing each customer with a number of services and becoming familiar with and addressing customer needs in a proactive, personalized fashion. The Bank currently has a total of twenty branch offices, including nine in Northern Virginia, six in Suburban Maryland, and five in Washington, D.C.

 

The Bank offers a broad range of commercial banking services to its business and professional clients as well as full service consumer banking services to individuals living and/or working primarily in the Bank’s market area. The Bank emphasizes providing commercial banking services to sole proprietors, small and medium-sized businesses, non-profit organizations and associations, and investors living and working in and near the primary service area. These services include the usual deposit functions of commercial banks, including business and personal checking accounts, “NOW” accounts and money market and savings accounts, business, construction, and commercial loans, residential mortgages and consumer loans, and cash management services. The Bank is also active in the origination and sale of residential mortgage loans and the origination of SBA loans. The residential mortgage loans are originated for sale to third-party investors, generally large mortgage and banking companies, under best efforts and mandatory delivery commitments with the investors to purchase the loans subject to compliance with pre-established criteria. The Bank generally sells the guaranteed portion of the SBA loans in a transaction apart from the loan origination generating noninterest income from the gains on sale, as well as servicing income on the portion participated. The Company originates multifamily FHA loans through the Department of Housing and Urban Development’s Multifamily Accelerated Program (“MAP”). The Company securitizes these loans through the Government National Mortgage Association (”Ginnie Mae”) MBS I program and sells the resulting securities in the open market to authorized dealers in the normal course of business and generally retainsperiodically bundles and sells the servicing rights. Bethesda Leasing, LLC, a subsidiary of the Bank, holds title to and manages other real estate owned (“OREO”) assets. Eagle Insurance Services, LLC, a subsidiary of the Bank, offers access to insurance products and services through a referral program with a third party insurance broker. Additionally, the Bank offers investment advisory services through referral programs with third parties. Landroval Municipal Finance, Inc., a subsidiary of the Bank, focuses on lending to municipalities by buying debt on the public market as well as direct purchase issuance.

 

CRITICAL ACCOUNTING POLICIES

 

The Company’s Consolidated Financial Statements are prepared in accordance with GAAP and follow general practices within the banking industry. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions and judgments are based on information available as of the date of the Consolidated Financial Statements; accordingly, as this information changes, the Consolidated Financial Statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions and judgments and, as such, have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value, when a decline in the value of an asset not carried on the financial statements at fair value warrants an impairment write-down or a valuation reserve to be established, or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The Company applies the accounting policies contained in Note 1 to Consolidated Financial Statements included in the Company’s Annual report on Form 10-K for the year ended December 31, 2017.2018. There have been no significant changes to the Company’s Accounting Policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

2018 except as indicated in “Accounting Standards Adopted in 2019” in Note 1.


RESULTS OF OPERATIONS

 

Earnings Summary

 

Net income for the three months ended SeptemberJune 30, 20182019 was $38.9$37.2 million a 30% increase over the $29.9compared to $37.3 million net income for the three months ended SeptemberJune 30, 2017.2018. Net income per basic common share for the three months ended SeptemberJune 30, 20182019 was $1.14$1.08 compared to $0.87$1.09 for the same period in 2017, a 31% increase.2018. Net income per diluted common share was $1.08 for both the three months ended June 30, 2019 and June 30, 2018.

Net income remained flat for the three months ended SeptemberJune 30, 2018 was $1.13 compared2019 relative to $0.87 for the same period in 2017, a 30% increase.

The increase in net income for the three months ended September 30, 2018 can be attributed primarilydue to an increase in total revenuehigher revenues (i.e. net interest income plus noninterest income) of 10% over the same period in 2017 and to the reductionoffset by higher expenses in the federal corporate tax rate from 35% to 21% pursuant to The Tax Cuts and Jobs Act of 2017.2019 period. The provision for income taxes was $13.9$13.5 million, a decreasean increase of $3.5 million$959 thousand or 20%8% compared to the same period in 2017.2018. The most significant portion of revenue is net interest income, which increased 13%4% for the three months ended SeptemberJune 30, 20182019 over the same period in 20172018 ($81.3 million versus $71.9$78.2 million), resulting from growth in average earning assets of 13%, together with a stable net interest margin.10%.

 

For the three months ended SeptemberJune 30, 2018,2019, the Company reported an annualized return on average assets (“ROAA”) of 1.93%1.74% as compared to 1.66%1.92% for the three months ended SeptemberJune 30, 2017.2018. The annualized return on average common equity (“ROACE”) for the three months ended SeptemberJune 30, 20182019 was 14.85%12.81% as compared to 12.86%14.93% for the three months ended SeptemberJune 30, 2017.2018. The annualized return on average tangible common equity (“ROATCE”) for the three months ended SeptemberJune 30, 20182019 was 16.54%14.08% as compared to 14.55%16.71% for the three months ended SeptemberJune 30, 2017.2018. The decline in these ratios was primarily due to a decline in the net interest margin.

 

For the ninesix months ended SeptemberJune 30, 2018,2019, the Company’s net income was $112.0$71.0 million, a 32% increase over3% decrease from the $84.7$73.0 million of net income for the same period in 2017.2018. Net income per basic common share for the ninesix months ended SeptemberJune 30, 20182019 was $3.26$2.06 compared to $2.48$2.13 for the same period in 2017,2018, a 31% increase.3% decrease. Net income per diluted common share for the ninesix months ended SeptemberJune 30, 20182019 was $3.25$2.05 compared to $2.47$2.12 for the same period in 2017,2018, a 32% increase.3% decrease.

 

The increasedecrease in net income for the ninesix months ended SeptemberJune 30, 20182019 can be attributed primarily to an increase$6.2 million in total revenue (i.e. net interest income plus noninterest income)nonrecurring charges recognized during the first quarter of 10% over2019 related to share based compensation awards and the same period in 2017retirement of our former Chairman and to the reduction in the federal corporate tax rate from 35% to 21% pursuant to The Tax Cuts and Jobs Act of 2017.Chief Executive Officer, Mr. Ronald D. Paul. The provision for income taxes was $38.7$25.4 million, a decreasean increase of $11.4 million$575 thousand or 23%2% compared to the same period in 2017.2018. The most significant portion of revenue is net interest income, which increased 13%5% for the ninesix months ended SeptemberJune 30, 20182019 over the same period in 20172018 ($235.3162.3 million versus $208.5$154.0 million), resulting from growth in average earning assets of 13%, together with a relatively stable net interest margin.11%.

 

For the ninesix months ended SeptemberJune 30, 2018,2019, the Company reported an annualized ROAA of 1.92%1.68% as compared to 1.63%1.91% for the ninesix months ended SeptemberJune 30, 2017.2018. The annualized ROACE for the ninesix months ended SeptemberJune 30, 20182019 was 14.92%12.47% as compared to 12.71%14.96% for the ninesix months ended SeptemberJune 30, 2017.2018. The annualized ROATCE for the ninesix months ended SeptemberJune 30, 20182019 was 16.70%13.73% as compared to 14.44%16.78% for the ninesix months ended SeptemberJune 30, 2017.2018. The decline in these ratios was primarily due to a decline in the net interest margin.

 

The net interest margin, which measures the difference between interest income and interest expense (i.e. net interest income) as a percentage of earning assets, was 4.14%3.91% for both the three months ended SeptemberJune 30, 20182019 and 2017.4.15% for the same period in 2018. Average earning asset yields increased 4710 basis points to 5.21% for the three months ended SeptemberJune 30, 2018,2019, as compared to 4.74%5.11% for the same period in 2017.2018. The average cost of interest bearing liabilities increased by 7852 basis points (to 1.75%2.06% from 0.97%1.54%) for the three months ended SeptemberJune 30, 20182019 as compared to the same period in 2017.2018. Combining the change in the yield on earning assets and the costs of interest bearing liabilities, the net interest spread decreased by 3142 basis points for the three months ended SeptemberJune 30, 20182019 as compared to 2017 (3.46%2018 (3.15% versus 3.77%3.57%).

 


The benefit of noninterest sources funding earning assets increased by 3118 basis points to 6876 basis points from 3758 basis points for the three months ended SeptemberJune 30, 20182019 versus the same period in 2017.2018. The combination of a 3142 basis point decrease in the net interest spread and a 31an 18 basis point increase in the value of noninterest sources leftresulted in a 24 basis point decrease in the net interest margin unchanged for the three months ended SeptemberJune 30, 20182019 as compared to the same period in 2017.2018. The Company considers the value of its noninterest sources of funds as very significant to its business model and its overall profitability.


The net interest margin was 4.15%3.97% for the ninesix months ended SeptemberJune 30, 20182019 and 4.14%4.16% for the same period in 2017.2018. Average earning asset yields increased 20 basis points to 5.08%5.21% for the ninesix months ended SeptemberJune 30, 2018,2019, as compared to 4.72%5.01% for the same period in 2017.2018. The average cost of interest bearing liabilities increased by 5764 basis points (to 1.50%2.01% from 0.93%1.37%) for the ninesix months ended SeptemberJune 30, 20182019 as compared to the same period in 2017.2018. Combining the change in the yield on earning assets and the costs of interest bearing liabilities, the net interest spread decreased by 2144 basis points for the ninesix months ended SeptemberJune 30, 20182019 as compared to 2017 (3.58%2018 (3.20% versus 3.79%3.64%).

 

The benefit of noninterest sources funding earning assets increased by 2225 basis points to 5777 basis points from 3552 basis points for the ninesix months ended SeptemberJune 30, 20182019 versus the same period in 2017.2018. The combination of a 2144 basis point decrease in the net interest spread and a 2225 basis point increase in the value of noninterest sources increasedresulted in a 19 basis point decrease in the net interest margin by one basis point for the ninesix months ended SeptemberJune 30, 20182019 as compared to the same period in 2017.2018.

 

The Company believes it has effectively managed its net interest margin and net interest income over the past twelve months as market interest rates (on average) have trended higher. This factor has been significant to overall earnings performance over the past twelve months as net interest income represents 94%93% of the Company’s total revenue for the three months ended SeptemberJune 30, 2018.2019.

 

For the first ninesix months of 2018,2019, total loans grew 7%6% over December 31, 2017,2018, and average loans were 12%10% higher in the first ninesix months of 20182019 as compared to the first ninesix months of 2017.2018. At SeptemberJune 30, 2018,2019, total deposits were 9% higherslightly lower than deposits at December 31, 2017,2018, while average deposits were 10%13% higher for the first ninesix months of 20182019 compared with the first ninesix months of 2017.2018.

 

In order to fund growth in average loans of 12%10% over the ninesix months ended SeptemberJune 30, 20182019 as compared to the same period in 2017,2018, as well as sustain significant liquidity, the Company has relied on both core deposit growth and brokered deposits. The major component of the growth in core deposits during the third quarter of 2018 has been growth in both noninterestfunding from interest bearing accounts primarily as a result of effectively building new and enhanced client relationships, and to a focus on time deposit programdeposits to lock in more fixed rate deposits at terms approximating 16 months.

 

In terms of the average asset composition or mix, loans, which generally have higher yields than securities and other earning assets, represented 86%87% of average earning assets for both the first ninesix months of 2018 compared to 87% for the same period in 2017.2019 and 2018. For the first ninesix months of 2018,2019, as compared to the same period in 2017,2018, average loans, excluding loans held for sale, increased $700.9$648.1 million, a 12%10% increase, due primarily to growth in income producing - commercial real estate, commercial, and owner occupied - commercial real estate, and commercial loans. Average investment securities for the ninesix months ended SeptemberJune 30, 20182019 and 20172018 amounted to 9%10% and 8% of average earning assets, respectively. The combination of federal funds sold, interest bearing deposits with other banks and loans held for sale represented 5%4% of average earning assets for both the first ninesix months of 20182019 and 2017. The average combination of federal funds sold, interest bearing deposits with other banks and loans held for sale increased $29.6 million for the nine months ended September 30, 2018 as compared to the same period in 2017.2018.

 

The provision for credit losses was $2.4$3.6 million for the three months ended SeptemberJune 30, 20182019 as compared to $1.9$1.7 million for the three months ended SeptemberJune 30, 2017.2018. Net charge-offs of $862 thousand$1.5 million in the thirdsecond quarter of 20182019 represented an annualized 0.08% of average loans, excluding loans held for sale, as compared to $848 thousand, or an annualized 0.05% of average loans, excluding loans held for sale, as compared to $2 thousand, or an annualized 0.00% of average loans, excluding loans held for sale, in the thirdsecond quarter of 2017.2018. Net charge-offs in the thirdsecond quarter of 20182019 were attributable primarily to commercial loans ($1.1 million) offset by a net recovery in commercial real estate loans ($254 thousand)1.5 million).

 

At SeptemberJune 30, 20182019 the allowance for credit losses represented 1.00%0.98% of loans outstanding, as compared to 1.01%1.00% at December 31, 2017 and 1.03% at September 30, 2017.2018. The decrease in the allowance for credit losses as a percentagerepresented 193% of totalnonperforming loans at SeptemberJune 30, 2018,2019, as compared to September 30, 2017, is the result of loan growth and continued asset quality. The allowance at September 30, 2018 for credit losses represented 452% of nonperforming loans, as compared to 489%430% at December 31, 2017, and 379%2018.  The lower ratio was due to anincrease in nonperforming loans at SeptemberJune 30, 2017.2019, substantially attributable to softness in the market for high-end residential properties.

 


Total noninterest income for the three months ended SeptemberJune 30, 2018 decreased2019 increased to $5.6$6.4 million from $6.8$5.6 million for the three months ended SeptemberJune 30, 2017,2018, a 17% decrease,15% increase, due substantially to lower$537 thousand higher gains on the sale of investment securities and $362 thousand higher gains on the sale of residential mortgage loans ($1.41.9 million versus $1.8$1.5 million) resulting from lowerhigher volume as compared to 2017, and minimal revenue associated with the origination, securitization, servicing, and sale of FHA Multifamily-Backed GNMA securities as compared to $780 thousand during the third quarter of 2017.2018. Residential mortgage loans closed were $107$152 million for the thirdsecond quarter of 20182019 versus $135$126 million for the same period in 2017.second quarter of 2018.

 

The efficiency ratio, which measures the ratio of noninterest expense to total revenue, was 36.37%38.04% for the thirdsecond quarter of 2018,2019, as compared to 37.49%38.55% for the thirdsecond quarter of 2017.2018. Noninterest expenses totaled $31.6$33.4 million for the three months ended SeptemberJune 30, 2018,2019, as compared to $29.5$32.3 million for the three months ended SeptemberJune 30, 2017,2018, a 7%3% increase. Salaries and employee benefits increased $252 thousand due to a larger staff and merit increases partially offset by lower incentive compensation accruals. Marketing and advertising costs increased $459 thousand due primarily to print and digital advertising. Data processing expense increased by $404$199 thousand due primarily to the costs of software and infrastructure investments. Legal, accounting and professional fees increased $890$561 thousand from $2.2 million to $2.7 million, the reasons of which are further discussed in the “Noninterest Expense” section. Other expenses increased $448 thousand, due substantiallyprimarily to advisory services associated with enhancing our risk management systems including corporate governance as we approach $10 billion in$354 thousand higher real estate and utility costs on special assets.


The provision for credit losses was $6.1$7.0 million for the ninesix months ended SeptemberJune 30, 20182019 as compared to $4.9$3.6 million for the ninesix months ended SeptemberJune 30, 2017.2018. The higher provisioning for the ninesix months ended SeptemberJune 30, 2018,2019, as compared to the same period in 2017,2018, is due primarily to higher net charge-offs. Net charge-offs of $2.6$4.8 million for the ninesix months ended SeptemberJune 30, 20182019 represented an annualized 0.13% of average loans, excluding loans held for sale, as compared to $1.8 million, or an annualized 0.05% of average loans, excluding loans held for sale, as compared to $991 thousand, or an annualized 0.02% of average loans, excluding loans held for sale, in the first ninesix months of 2017.2018. Net charge-offs in the first ninesix months of 20182019 were attributable primarily to commercial real estate loans ($2.45.0 million) offset by a recovery in commercial loans ($162 thousand).

 

Total noninterest income for the ninesix months ended SeptemberJune 30, 2018 decreased2019 increased to $16.5$12.7 million from $19.9$10.9 million for the ninesix months ended SeptemberJune 30, 2017,2018, a 17% decrease,increase, due substantially to lower$1.4 million higher gains on the sale of investment securities primarily due to $829 thousand of noninterest income recognized during March 2019 on interest rate swap terminations, and $288 thousand higher gains on the sale of residential mortgage loans ($4.33.2 million versus $6.1$2.9 million) resulting from lowerhigher volume as compared to 2017, and minimal revenue associated with the origination, securitization, servicing, and sale of FHA Multifamily-Backed GNMA securities2018. Residential mortgage loans closed were $246 million for the ninesix months ended SeptemberJune 30, 20182019 versus $1.5$226 million for the same period in 2017. Residential mortgage loans closed were $334 million2018.

The efficiency ratio, which measures the ratio of noninterest expense to total revenue, was 40.95% for the ninefirst six months ended September 30, 2018 versus $473 millionof 2019, as compared to 38.47% for the same period in 2017.

For2018. Noninterest expenses totaled $71.7 million for the first ninesix months of 2018, the efficiency ratio was 37.74%ended June 30, 2019, as compared to 38.86% for the same period in 2017. Noninterest expenses totaled $95.0$63.4 million for the ninesix months ended SeptemberJune 30, 2018, as compared to $88.7 million for the nine months ended September 30, 2017, a 7%13% increase. Cost increases for salaries and benefits for the ninesix months ended SeptemberJune 30, 20182019 were $1.4$6.7 million, due primarily to $6.2 million of nonrecurring charges related to share based compensation and the retirement of our former Chairman and Chief Executive Officer, Mr. Ronald D. Paul, and secondly to increased staff and merit increases.overall headcount. Marketing and advertising costsexpense increased $546by $188 thousand due primarily to printincreased digital, radio and digital advertising.television advertising spend. Data processing expense increased by $1.1 million$257 thousand due primarily to the costs of software and infrastructure investments. Legal, accounting, and professional fees increased $3.7decreased $703 thousand from $5.2 million due substantially to both first and second quarter due diligence costs from independent consultants associated with$4.4 million, the internet event latereasons of which are further discussed in 2017 as well as costs to enhance risk management systems, including corporate governance as we approach $10 billion in assets.the “Noninterest Expense” section. Other expenses decreased $1.1increased $1.5 million, for the nine months ended September 30, 2018 compared to the same period in 2017, due primarily to a $361 thousand net lossbroker fees ($554 thousand) and real estate and utility costs on the sale of OREO in the first quarter of 2017 and a $377 thousand decrease in costs associated with problem loans.special assets ($369 thousand).

 

The ratio of common equity to total assets increased to 13.18%13.66% at SeptemberJune 30, 20182019 from 12.71%13.22% at December 31, 2017,2018, due primarily to retained earnings. As discussed later in “Capital Resources and Adequacy,” the regulatory capital ratios of the Bank and Company remain above well capitalized levels.

 

Net Interest Income and Net Interest Margin

 

Net interest income is the difference between interest income on earning assets and the cost of funds supporting those assets. Earning assets are composed primarily of loans and investment securities. The cost of funds represents interest expense on deposits, customer repurchase agreements and other borrowings. Noninterest bearing deposits and capital are other components representing funding sources (refer to discussion above under Results of Operations). Changes in the volume and mix of assets and funding sources, along with the changes in yields earned and rates paid, determine changes in net interest income.

 


For the three months ended SeptemberJune 30, 2018,2019, net interest income increased 13%4% over the same period for 2017.2018. Average loans increased by $699.9$691.0 million and average deposits increased by $657.2$624.9 million. The net interest margin was 4.14%3.91% for both the three months ended SeptemberJune 30, 20182019 and 2017.4.15% for the same period in 2018.

 

For the ninesix months ended SeptemberJune 30, 2018,2019, net interest income increased 13%5% over the same period for 2017.2018. Average loans increased by $700.9$648.1 million and average deposits increased by $592.1$773.8 million. The net interest margin was 4.15%3.97% for the ninesix months ended SeptemberJune 30, 20182019 and 4.14%4.16% for the same period in 2017.2018. The Company believes its current net interest margin remains favorable as compared to its peer banking companies.

 

The tables below present the average balances and rates of the major categories of the Company’s assets and liabilities for the three and ninesix months ended SeptemberJune 30, 20182019 and 2017.2018. Included in the tablestable is a measurement of interest rate spread and margin. Interest rate spread is the difference (expressed as a percentage) between the interest rate earned on earning assets less the interest rate paid on interest bearing liabilities. While the interest rate spread provides a quick comparison of earnings rates versus cost of funds, management believes that margin provides a better measurement of performance. The net interest margin (as compared to net interest spread) includes the effect of noninterest bearing sources in its calculation. Net interest margin is net interest income expressed as a percentage of average earning assets.


Eagle Bancorp, Inc.

Consolidated Average Balances, Interest Yields And Rates(Unaudited)

(dollars in thousands)

                   
  Three Months Ended September 30, 
  2018  2017 
  Average
Balance		  Interest  Average
Yield/Rate		  Average
Balance		  Interest  Average
Yield/Rate		 
ASSETS                  
Interest earning assets:                        
Interest bearing deposits with other banks and other short-term investments $377,324  $1,897   1.99% $331,194  $991   1.19%
Loans held for sale (1)  23,511   274   4.66%  37,146   350   3.77%
Loans (1) (2)  6,646,264   95,296   5.69%  5,946,411   77,826   5.19%
Investment securities available for sale (2)  735,586   4,875   2.63%  576,423   3,194   2.20%
Federal funds sold  10,737   18   0.67%  6,439   9   0.55%
Total interest earning assets  7,793,422   102,360   5.21%  6,897,613   82,370   4.74%
                         
Total noninterest earning assets  297,815           292,891         
Less: allowance for credit losses  67,702           61,735         
Total noninterest earning assets  230,113           231,156         
TOTAL ASSETS $8,023,535          $7,128,769         
                         
LIABILITIES AND SHAREHOLDERS’ EQUITY                        
Interest bearing liabilities:                        
Interest bearing transaction $482,820  $973   0.80% $406,923  $506   0.49%
Savings and money market  2,596,010   9,636   1.47%  2,663,762   4,211   0.63%
Time deposits  1,220,755   6,110   1.99%  866,595   2,516   1.15%
Total interest bearing deposits  4,299,585   16,719   1.54%  3,937,280   7,233   0.73%
Customer repurchase agreements  30,445   54   0.70%  73,345   58   0.31%
Other short-term borrowings  216,851   1,317   2.38%  54,840   164   1.17%
Long-term borrowings  217,164   2,979   5.37%  216,774   2,979   5.38%
Total interest bearing liabilities  4,764,045   21,069   1.75%  4,282,239   10,434   0.97%
                         
Noninterest bearing liabilities:                        
Noninterest bearing demand  2,185,559           1,890,673         
Other liabilities  33,105           34,364         
Total noninterest bearing liabilities  2,218,664           1,925,037         
                         
Shareholders’ equity  1,040,826           921,493         
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $8,023,535          $7,128,769         
                         
Net interest income     $81,291          $71,936     
Net interest spread          3.46%          3.77%
Net interest margin          4.14%          4.14%
Cost of funds          1.07%          0.60%

  Three Months Ended June 30, 
  2019  2018 
  Average
Balance		  Interest  Average
Yield/Rate		  Average
Balance		  Interest  Average
Yield/Rate		 
ASSETS                  
Interest earning assets:                        
Interest bearing deposits with other banks and other short-term investments $209,096  $1,105   2.12% $302,991  $1,274   1.69%
Loans held for sale (1)  34,760   349   4.02%  25,621   291   4.54%
Loans (1) (2)  7,260,899   101,540   5.61%  6,569,931   90,633   5.53%
Investment securities available for sale (2)  803,207   5,238   2.62%  643,409   4,058   2.53%
Federal funds sold  20,361   47   0.93%  16,186   40   0.99%
     Total interest earning assets  8,328,323   108,279   5.21%  7,558,138   96,296   5.11%
                         
Total noninterest earning assets  337,172           297,601         
Less: allowance for credit losses  69,972           66,175         
     Total noninterest earning assets  267,200           231,426         
     TOTAL ASSETS $8,595,523          $7,789,564         
                         
LIABILITIES AND SHAREHOLDERS’ EQUITY                        
Interest bearing liabilities:                        
Interest bearing transaction $705,628  $1,197   0.68% $444,842  $815   0.73%
Savings and money market  2,628,255   12,279   1.87%  2,647,910   8,546   1.29%
Time deposits  1,442,197   8,985   2.50%  1,123,330   4,687   1.67%
     Total interest bearing deposits  4,776,080   22,461   1.89%  4,216,082   14,048   1.34%
Customer repurchase agreements  33,248   75   0.90%  38,438   62   0.65%
Other short-term borrowings  219,508   1,435   2.59%  230,223   997   1.71%
Long-term borrowings  217,458   2,979   5.42%  217,068   2,979   5.43%
     Total interest bearing liabilities  5,246,294   26,950   2.06%  4,701,811   18,086   1.54%
                         
Noninterest bearing liabilities:                        
Noninterest bearing demand  2,117,901           2,053,044         
Other liabilities  64,841           32,618         
     Total noninterest bearing liabilities  2,182,742           2,085,662         
                         
Shareholders’ Equity  1,166,487           1,002,091         
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $8,595,523          $7,789,564         
                         
Net interest income     $81,329          $78,210     
Net interest spread          3.15%          3.57%
Net interest margin          3.91%          4.15%
Cost of funds          1.30%          0.96%

 

(1)Loans placed on nonaccrual status are included in average balances. Net loan fees and late charges included in interest income on loans totaled $5.0$4.7 million and $4.7$5.2 million for the three months ended SeptemberJune 30, 20182019 and 2017,2018, respectively.
(2)Interest and fees on loans and investments exclude tax equivalent adjustments.

 


46 

Eagle Bancorp, Inc.

Consolidated Average Balances, Interest Yields and Rates(Unaudited)

(dollars in thousands)

                   
  Nine Months Ended September 30, 
  2018  2017 
  Average
Balance		  Interest  Average
Yield/Rate		  Average
Balance		  Interest  Average
Yield/Rate		 
ASSETS                  
Interest earning assets:                        
Interest bearing deposits with other banks and other short-term investments $321,266  $4,152   1.73% $290,366  $2,084   0.96%
Loans held for sale (1)  24,692   839   4.53%  34,925   1,020   3.89%
Loans (1) (2)  6,550,754   270,085   5.51%  5,849,832   225,523   5.15%
Investment securities available for sale (2)  664,798   12,525   2.52%  541,378   8,854   2.19%
Federal funds sold  15,060   104   0.92%  6,163   27   0.59%
Total interest earning assets  7,576,570   287,705   5.08%  6,722,664   237,508   4.72%
                         
Total noninterest earning assets  294,948           292,700         
Less: allowance for credit losses  66,429           60,416         
Total noninterest earning assets  228,519           232,284         
TOTAL ASSETS $7,805,089          $6,954,948         
                         
LIABILITIES AND SHAREHOLDERS’ EQUITY                        
Interest bearing liabilities:                        
Interest bearing transaction $433,921  $2,252   0.69% $366,521  $1,081   0.39%
Savings and money market  2,670,578   23,846   1.19%  2,677,777   12,171   0.61%
Time deposits  1,078,608   13,798   1.71%  795,884   6,214   1.04%
Total interest bearing deposits  4,183,107   39,896   1.28%  3,840,182   19,466   0.68%
Customer repurchase agreements  45,504   166   0.49%  70,702   136   0.26%
Other short-term borrowings  228,398   3,425   1.98%  58,797   441   0.99%
Long-term borrowings  217,068   8,937   5.43%  216,675   8,937   5.44%
Total interest bearing liabilities  4,674,077   52,424   1.50%  4,186,356   28,980   0.93%
                         
Noninterest bearing liabilities:                        
Noninterest bearing demand  2,090,868           1,841,645         
Other liabilities  36,705           36,130         
Total noninterest bearing liabilities  2,127,573           1,877,775         
                         
Shareholders’ equity  1,003,439           890,817         
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $7,805,089          $6,954,948         
                         
Net interest income     $235,281          $208,528     
Net interest spread          3.58%          3.79%
Net interest margin          4.15%          4.14%
Cost of funds          0.93%          0.58%

  Six Months Ended June 30, 
  2019  2018 
  Average
Balance		  Interest  Average
Yield/Rate		  Average
Balance		  Interest  Average
Yield/Rate		 
ASSETS                  
Interest earning assets:                        
Interest bearing deposits with other banks and other short-term investments $254,804  $2,771   2.19% $292,772  $2,255   1.55%
Loans held for sale (1)  26,386   550   4.17%  25,293   565   4.47%
Loans (1) (2)  7,150,300   199,160   5.62%  6,502,207   174,789   5.42%
Investment securities available-for-sale (2)  806,858   10,836   2.71%  628,818   7,650   2.45%
Federal funds sold  19,063   96   1.02%  17,258   86   1.00%
Total interest earning assets  8,257,411   213,413   5.21%  7,466,348   185,345   5.01%
                         
Total noninterest earning assets  338,290           293,488         
Less: allowance for credit losses  69,713           65,781         
Total noninterest earning assets  268,577           227,707         
TOTAL ASSETS $8,525,988          $7,694,055         
                         
LIABILITIES AND SHAREHOLDERS’ EQUITY                        
Interest bearing liabilities:                        
Interest bearing transaction $648,557  $2,378   0.74% $409,066  $1,279   0.63%
Savings and money market  2,709,950   24,242   1.80%  2,708,480   14,210   1.06%
Time deposits  1,386,876   16,741   2.43%  1,006,356   7,688   1.54%
Total interest bearing deposits  4,745,383   43,361   1.84%  4,123,902   23,177   1.13%
Customer repurchase agreements  30,536   173   1.14%  53,158   112   0.42%
Other short-term borrowings  120,832   1,575   2.59%  234,267   2,108   1.79%
Long-term borrowings  217,408   5,958   5.45%  217,019   5,958   5.46%
Total interest bearing liabilities  5,114,159   51,067   2.01%  4,628,346   31,355   1.37%
                         
Noninterest bearing liabilities:                        
Noninterest bearing demand  2,195,084           2,042,738         
Other liabilities  68,963           38,535         
Total noninterest bearing liabilities  2,264,047           2,081,273         
                         
Shareholders’ equity  1,147,782           984,436         
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY $8,525,988          $7,694,055         
                         
Net interest income     $162,346          $153,990     
Net interest spread          3.20%          3.64%
Net interest margin          3.97%          4.16%
Cost of funds          1.24%          0.85%

 

(1)Loans placed on nonaccrual status are included in average balances. Net loan fees and late charges included in interest income on loans totaled $14.9$8.8 million and $12.9$9.9 million for the ninesix months ended SeptemberJune 30, 20182019 and 2017,2018, respectively.
(2)Interest and fees on loans and investments exclude tax equivalent adjustments.

47 

Provision for Credit Losses

 

 

The provision for credit losses represents the amount of expense charged to current earnings to fund the allowance for credit losses. The amount of the allowance for credit losses is based on many factors which reflect management’s assessment of the risk in the loan portfolio. Those factors include historical losses, economic conditions and trends, the value and adequacy of collateral, volume and mix of the portfolio, performance of the portfolio, and internal loan processes of the Company and Bank.

 

Management has developed a comprehensive analytical process to monitor the adequacy of the allowance for credit losses. The process and guidelines were developed utilizing, among other factors, the guidance from federal banking regulatory agencies. The results of this process, in combination with conclusions of the Bank’s outside loan review consultant, support management’s assessment as to the adequacy of the allowance at the balance sheet date. Please refer to the discussion under the caption “Critical Accounting Policies” contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 20172018 for an overview of the methodology management employs on a quarterly basis to assess the adequacy of the allowance and the provisions charged to expense. Also, refer to the table at page 49,46 which reflects activity in the allowance for credit losses.

 

During the three months ended SeptemberJune 30, 2018,2019, the allowance for credit losses increased $1.6 million, reflecting $2.4reflected $3.6 million in provision for credit losses and $862 thousand in net charge-offs during the period. The provision for credit losses was $2.4 million for the three months ended September 30, 2018 as compared to $1.9 million for the same period in 2017. Net charge-offs of $862 thousand in the third quarter of 2018 represented an annualized 0.05% of average loans, excluding loans held for sale, as compared to $2 thousand, or an annualized 0.00% of average loans, excluding loans held for sale, in the third quarter of 2017.

During the nine months ended September 30, 2018, the allowance for credit losses increased $3.4 million, reflecting $6.1 million in provision for credit losses and $2.6$1.5 million in net charge-offs during the period. The provision for credit losses was $6.1$3.6 million for the ninethree months ended SeptemberJune 30, 20182019 as compared to $4.9$1.7 million for the same period in 2017.2018. Net charge-offs of $2.6$1.5 million in the first nine monthssecond quarter of 20182019 represented an annualized 0.08% of average loans, excluding loans held for sale, as compared to $848 thousand, or an annualized 0.05% of average loans, excluding loans held for sale, in the second quarter of 2018.

During the six months ended June 30, 2019, the allowance for credit losses reflected $7.0 million in provision for credit losses and $4.8 million in net charge-offs during the period. The provision for credit losses was $7.0 million for the six months ended June 30, 2019 as compared to $991 thousand, or$3.6 million for the same period in 2018. Net charge-offs of $4.8 million in the first six months of 2019 represented an annualized 0.02%0.13% of average loans, excluding loans held for sale, as compared to $1.8 million, or an annualized 0.05% of average loans, excluding loans held for sale, in the same periodfirst six months of 2017.2018.

 

As part of its comprehensive loan review process, the Bank’s Board of Directors and Loan Committee or Credit Review Committee carefully evaluate loans which are past-due 30 days or more. The Committees make a thorough assessment of the conditions and circumstances surrounding each delinquent loan. The Bank’s loan policy requires that loans be placed on nonaccrual if they are ninety days past-due, unless they are well secured and in the process of collection. Additionally, Credit Administration specifically analyzes the status of development and construction projects, sales activities and utilization of interest reserves in order to carefully and prudently assess potential increased levels of risk requiring additional reserves.

 

The maintenance of a high quality loan portfolio, with an adequate allowance for possible credit losses, will continue to be a primary management objective for the Company.

48 

The following table sets forth activity in the allowance for credit losses for the periods indicated.

 

 Nine Months Ended September 30, 
   
(dollars in thousands) 2018  2017 
Balance at beginning of period $64,758  $59,074 
Charge-offs:        
Commercial  2,435   659 
Income producing - commercial real estate  121   1,470 
Owner occupied - commercial real estate  132   — 
Real estate mortgage - residential  —   — 
Construction - commercial and residential  1,160   39 
Construction - C&I (owner occupied)  —   — 
Home equity  —   — 
Other consumer  15   98 
Total charge-offs  3,863   2,266 
         
Recoveries:        
Commercial  86   675 
Income producing - commercial real estate  2   80 
Owner occupied - commercial real estate  2   2 
Real estate mortgage - residential  4   5 
Construction - commercial and residential  994   491 
Construction - C&I (owner occupied)  —   — 
Home equity  133   4 
Other consumer  13   18 
Total recoveries  1,234   1,275 
Net charge-offs  2,629   991 
Provision for Credit Losses  6,060   4,884 
Balance at end of period $68,189  $62,967 
         
Annualized ratio of net charge-offs during the period to average loans outstanding during the period  0.05%  0.02%

 Six Months Ended June 30, 
(dollars in thousands) 2019  2018 
Balance at beginning of period $69,944  $64,758 
Charge-offs:        
Commercial  5   1,261 
Income producing - commercial real estate  5,343   121 
Owner occupied - commercial real estate  —   132 
Real estate mortgage - residential  —   — 
Construction - commercial and residential  —   517 
Construction - C&I (owner occupied)  —   — 
Home equity  —   — 
Other consumer  2   — 
Total charge-offs  5,350   2,031 
         
Recoveries:        
Commercial  167   26 
Income producing - commercial real estate  302   2 
Owner occupied - commercial real estate  2   2 
Real estate mortgage - residential  3   3 
Construction - commercial and residential  37   95 
Construction - C&I (owner occupied)  —   — 
Home equity  —   127 
Other consumer  21   8 
Total recoveries  532   263 
Net charge-offs  4,818   1,768 
Provision for Credit Losses  6,960   3,619 
Balance at end of period $72,086  $66,609 
         
Annualized ratio of net charge-offs during the period  to average loans outstanding during the period  0.13%  0.05%

 

The following table reflects the allocation of the allowance for credit losses at the dates indicated. The allocation of the allowance to each category is not necessarily indicative of future losses or charge-offs and does not restrict the use of the allowance to absorb losses in any category.

 

  September 30, 2018 December 31, 2017
(dollars in thousands)  Amount   %(1)  Amount   %(1)
Commercial $15,649   22% $13,102   21%
Income producing - commercial real estate  27,387   46%  25,376   48%
Owner occupied - commercial real estate  5,931   13%  5,934   12%
Real estate mortgage - residential  749   2%  944   2%
Construction - commercial and residential  16,640   15%  17,805   15%
Construction - C&I (owner occupied)  899   1%  687   1%
Home equity  631   1%  770   1%
Other consumer  303   —   140   — 
Total allowance $68,189   100% $64,758   100%

(1)

Represents the percent of loans in each category to total loans.

  June 30, 2019  December 31, 2018 
(dollars in thousands) Amount  %(1)  Amount  %(1) 
Commercial $18,136   20% $15,857   22%
Income producing - commercial real estate  27,010   50%  28,034   46%
Owner occupied - commercial real estate  5,756   13%  6,242   13%
Real estate mortgage - residential  1,355   1%  965   2%
Construction - commercial and residential  17,674   14%  17,484   15%
Construction - C&I (owner occupied)  1,332   1%  691   1%
Home equity  581   1%  599   1%
Other consumer  242   —   72   — 
    Total allowance $72,086   100% $69,944   100%

 

49 (1)Represents the percent of loans in each category to total loans.

Nonperforming Assets

 

As shown in the table below, the Company’s level of nonperforming assets, which is comprised of loans delinquent 90 days or more, nonaccrual loans, which includes the nonperforming portion of TDRs, and OREO, totaled $16.5$38.8 million at SeptemberJune 30, 20182019 representing 0.20%0.45% of total assets, as compared to $14.6$17.7 million of nonperforming assets, or 0.20%0.21% of total assets, at December 31, 2017. 2018. The increase in nonperforming loans at June 30, 2019, was substantially attributable to softness in the market for high-end residential properties.

The Company had no accruing loans 90 days or more past due at SeptemberJune 30, 20182019 or December 31, 2017.2018. Management remains attentive to early signs of deterioration in borrowers’ financial conditions and to taking the appropriate action to mitigate risk. Furthermore, the Company is diligent in placing loans on nonaccrual status and believes, based on its loan portfolio risk analysis, that its allowance for credit losses, at 1.00%0.98% of total loans at SeptemberJune 30, 2018,2019, is adequate to absorb potential credit losses within the loan portfolio at that date.

 

Included in nonperforming assets are loans that the Company considers to be impaired. Impaired loans are defined as those as to which we believe it is probable that we will not collect all amounts due according to the contractual terms of the loan agreement, as well as those loans whose terms have been modified in a TDR that have not shown a period of performance as required under applicable accounting standards. Valuation allowances for those loans determined to be impaired are evaluated in accordance with ASC Topic 310—“Receivables,” and updated quarterly. For collateral dependent impaired loans, the carrying amount of the loan is determined by current appraised value less estimated costs to sell the underlying collateral, which may be adjusted downward under certain circumstances for actual events and/or changes in market conditions. For example, current average actual selling prices less average actual closing costs on an impaired multi-unit real estate project may indicate the need for an adjustment in the appraised valuation of the project, which in turn could increase the associated ASC Topic 310 specific reserve for the loan. Generally, all appraisals associated with impaired loans are updated on a not less than annual basis.

 

Loans are considered to have been modified in a TDR when, due to a borrower’s financial difficulties, the Company makes unilateral concessions to the borrower that it would not otherwise consider. Concessions could include interest rate reductions, principal or interest forgiveness, forbearance, and other actions intended to minimize economic loss and to avoid foreclosure or repossession of collateral. Alternatively, management, from time-to-time and in the ordinary course of business, implements renewals, modifications, extensions, and/or changes in terms of loans to borrowers who have the ability to repay on reasonable market-based terms, as circumstances may warrant. Such modifications are not considered to be TDRs as the accommodation of a borrower’s request does not rise to the level of a concession if the modified transaction is at market rates and terms and/or the borrower is not experiencing financial difficulty. For example: (1) adverse weather conditions may create a short term cash flow issue for an otherwise profitable retail business which suggests a temporary interest only period on an amortizing loan; (2) there may be delays in absorption on a real estate project which reasonably suggests extension of the loan maturity at market terms; or (3) there may be maturing loans to borrowers with demonstrated repayment ability who are not in a position at the time of maturity to obtain alternate long-term financing. The determination of whether a restructured loan is a TDR requires consideration of all of the facts and circumstances surrounding the change in terms, and the exercise of prudent business judgment. The Company had fourteeneleven TDR’s at SeptemberJune 30, 20182019 totaling approximately $18.3$11.4 million. TenSeven of these loans totaling approximately $17.5$8.6 million are performing under their modified terms. There was one performing TDR totaling $2.3 million that defaulted on its modified terms which was reclassified to nonperforming loans during the six months ended June 30, 2019, as compared to the six months ended June 30, 2018, there were two performing TDRs totaling $937 thousand that defaulted on their modified terms which were reclassified to nonperforming loans during the nine months ended September 30, 2018, as compared to the same period in 2017, which had one default on a $237 thousand restructured loan which was charged off.loans. A default is considered to have occurred once the TDR is past due 90 days or more or it has been placed on nonaccrual. For the three months ended June 30, 2019, there was one restructured loan totaling approximately $4.8 million that had its collateral property sold for approximately $3 million and the remaining $1.8 million was charged-off during the quarter, as compared to the same period in 2018, there was one defaulted loan totaling approximately $315 thousand that was charged-off.  During the three months ended June 30, 2019, there was one loan totaling $10.4 million that was re-underwritten into two new loans which provided better collateral for the Bank, as compared to the three months ended June 30, 2018, there was one loan totaling $274 thousand that was partially paid off from the sale proceeds of the business which totaled approximately $236 thousand, the remaining balance on the loan of $38 thousand was charged-off. Commercial and consumer loans modified in a TDR are closely monitored for delinquency as an early indicator of possible future default. If loans modified in a TDR subsequently default, the Company evaluates the loan for possible further impairment. The allowance may be increased, adjustments may be made in the allocation of the allowance, or partial charge-offs may be taken to further write-down the carrying value of the loan. For the three months ended SeptemberJune 30, 20108,2019, there was one loan totaling $2.4 millionwere no loans modified in a TDR, as compared to the three months ended SeptemberJune 30, 20172018 which had two loans totaling $251 thousand modified in a TDR. For the nine months ended September 31, 2018, there were three loans totaling $6.4 million modified in a TDR, as compared to the nine months ended September 30, 2017 which had three loans totaling $5.1$4.0 million modified in a TDR.


 

Total nonperforming loans amounted to $15.1$37.4 million at SeptemberJune 30, 2018 (0.22%2019 (0.51% of total loans) compared to $13.2$16.3 million at December 31, 2017 (0.21%2018 (0.23% of total loans). The slight increase in the ratio of nonperforming loans to total loans at SeptemberJune 30, 20182019 as compared to December 31, 20172018 was due to an increaseincreased nonperforming loans substantially attributable to softness in the level of nonperforming loans.market for high-end residential properties.

50 

 

Included in nonperforming assets at SeptemberJune 30, 20182019 and December 31, 20172018 was $1.4 million of OREO, consisting of one foreclosed property. The Company had one foreclosed property with a net carrying value of $1.4 million at SeptemberJune 30, 2017.2018. OREO properties are carried at fair value less estimated costs to sell. It is the Company’s policy to obtain third party appraisals prior to foreclosure, and to obtain updated third party appraisals on OREO properties generally not less frequently than annually. Generally, the Company would obtain updated appraisals or evaluations where it has reason to believe, based upon market indications (such as comparable sales, legitimate offers below carrying value, broker indications and similar factors), that the current appraisal does not accurately reflect current value. During the first nine months of 2018 thereThere were no sales of OREO property. Duringproperty during the first ninesix months of 2017, three foreclosed properties with a net carrying value of $2.5 million were sold for a net loss of $301 thousand.2019 and 2018.

 

The following table shows the amounts of nonperforming assets at the dates indicated.

 

  September 30,  December 31, 
(dollars in thousands) 2018  2017 
Nonaccrual Loans:        
Commercial $7,529  $3,493 
Income producing - commercial real estate  48   832 
Owner occupied - commercial real estate  2,370   5,501 
Real estate mortgage - residential  1,522   775 
Construction - commercial and residential  3,030   2,052 
Construction - C&I (owner occupied)  —   — 
Home equity  487   494 
Other consumer  91   91 
Accrual loans - past due 90 days  —   — 
Total nonperforming loans (1)  15,077   13,238 
Other real estate owned  1,394   1,394 
Total nonperforming assets $16,471  $14,632 
         
Coverage ratio, allowance for credit losses to total nonperforming loans  452.28%  489.20%
Ratio of nonperforming loans to total loans  0.22%  0.21%
Ratio of nonperforming assets to total assets  0.20%  0.20%

  June 30,  December 31, 
(dollars in thousands) 2019  2018 
Nonaccrual Loans:        
Commercial $16,053  $7,115 
Income producing - commercial real estate  4,563   1,766 
Owner occupied - commercial real estate  1,510   2,368 
Real estate mortgage - residential  5,640   1,510 
Construction - commercial and residential  9,155   3,031 
Construction - C&I (owner occupied)  —   — 
Home equity  487   487 
Other consumer  —   — 
Accrual loans-past due 90 days  —   — 
Total nonperforming loans (1)  37,408   16,277 
Other real estate owned  1,394   1,394 
Total nonperforming assets $38,802  $17,671 
         
Coverage ratio, allowance for credit losses to total nonperforming loans  192.70%  429.72%
Ratio of nonperforming loans to total loans  0.51%  0.23%
Ratio of nonperforming assets to total assets  0.45%  0.21%

 

(1)Nonaccrual loans reported in the table above include loansone loan totaling $2.3 million that migrated from a performing troubled debt restructuring. ThereTDRs during the six months ended June 30, 2019, as compared to the six months ended June 30, 2018 where there were two loans totaling $937 thousand that migrated from performing TDRs during the nine months ended September 30, 2018, as compared to the nine months ended September 30, 2017 where there were two loans totaling $588 thousand that migrated from performing TDR.TDRs.  

 

Significant variation in the amount of nonperforming loans may occur from period to period because the amount of nonperforming loans depends largely on the condition of a relatively small number of individual credits and borrowers relative to the total loan portfolio.

 

At SeptemberJune 30, 2018,2019, there were $32.1$46.6 million of performing loans considered potential problem loans, defined as loans that are not included in the 90 day past due, nonaccrual or restructured categories, but for which known information about possible credit problems causes management to be uncertain as to the ability of the borrowers to comply with the present loan repayment terms, which may in the future result in disclosure in the past due, nonaccrual or restructured loan categories. The $32.1 million in potentialPotential problem loans decreased to $46.6 million at SeptemberJune 30, 2018 compared to $18.82019 from $102.7 million at December 31, 2017.2018. The Company has taken a conservative posture with respect to risk rating its loan portfolio. Based upon their status as potential problem loans, these loans receive heightened scrutiny and ongoing intensive risk management. Additionally, the Company’s loan loss allowance methodology incorporates increased reserve factors for certain loans considered potential problem loans as compared to the general portfolio. See “Provision for Credit Losses” for a description of the allowance methodology.

 


Noninterest Income

 

Total noninterest income includes service charges on deposits, gain on sale of loans, gain on sale of investment securities, income from BOLI and other income.

 

51 

Total noninterest income for the three months ended SeptemberJune 30, 2018 decreased2019 increased to $5.6$6.4 million from $6.8$5.6 million for the three months ended SeptemberJune 30, 2017,2018, a 17% decrease,15% increase, due substantially to lower$537 thousand higher gains on the sale of investment securities and $362 thousand higher gains on the sale of residential mortgage loans ($1.41.9 million versus $1.8$1.5 million) resulting from lowerhigher volume as compared to 2017, and minimal revenue associated with the origination, securitization, servicing, and sale of FHA Multifamily-Backed GNMA securities as compared to $780 thousand during the third quarter of 2017.2018. Residential mortgage loans closed were $107$152 million for the thirdsecond quarter of 2019 versus $126 million for the second quarter of 2018. Gains on sale of FHA multifamily loan securities in the second quarter of 2019 were $81 thousand versus zero in the second quarter of 2018.

Total noninterest income for the six months ended June 30, 2019 increased to $12.7 million from $10.9 million for the six months ended June 30, 2018, a 17% increase. The increase was due substantially to $1.4 million higher gains on the sale of investment securities, primarily due to $829 thousand of noninterest income recognized during March 2019 on interest rate swap terminations, and $288 thousand higher gains on the sale of residential mortgage loans ($3.2 million versus $135$2.9 million) resulting from higher volume as compared to 2018. Residential mortgage loans closed were $246 million for the six months ended June 30, 2019 versus $226 million for the same period in 2017.2018. Gains on sale of FHA multifamily loan securities in the first six months of 2019 were $137 thousand versus $48 thousand in the same period of 2018.

 

Servicing agreements relating to the Ginnie Mae mortgage-backed securities program require the Company to advance funds to make scheduled payments of principal, interest, taxes and insurance, if such payments have not been received from the borrowers. The Company will generally recover funds advanced pursuant to these arrangements under the FHA insurance and guarantee program. However, in the interim, the Company must absorb the cost of the funds it advances during the time the advance is outstanding. The Company must also bear the costs of attempting to collect on delinquent and defaulted mortgage loans. In addition, if a defaulted loan is not cured, the mortgage loan would be canceled as part of the foreclosure proceedings and the Company would not receive any future servicing income with respect to that loan. At SeptemberJune 30, 2018,2019, the Company had no funds advanced outstanding under FHA mortgage loan servicing agreements. To the extent the mortgage loans underlying the Company’s servicing portfolio experience delinquencies, the Company would be required to dedicate cash resources to comply with its obligation to advance funds as well as incur additional administrative costs related to increases in collection efforts.

 

Total noninterest income for the nine months ended September 30, 2018Service charges on deposit accounts decreased to $16.5 millionby $154 thousand, or 9%, from $19.9$1.8 million for the ninethree months ended September 30, 2017, a 17% decrease, due substantially to lower gains on the sale of residential mortgage loans ($4.3 million versus $6.1 million) resulting from lower volume as compared to 2017, and minimal revenue associated with the origination, securitization, servicing, and sale of FHA Multifamily-Backed GNMA securities for the nine months ended SeptemberJune 30, 2018 versus $1.5to $1.6 million for the same period in 2017. Residential mortgage loans closed were $3342019. Service charges on deposit accounts decreased by $74 thousand, or 2%, from $3.4 million for the ninesix months ended SeptemberJune 30, 2018 versus $473to $3.3 million for the same period in 2017.

Service charges on deposit accounts increased by $188 thousand, or 12%, from $1.6 million for the three months ended September 30, 2017 to $1.8 million for the same period in 2018. Service charges on deposit accounts increased by $547 thousand, or 12%, from $4.6 million for the nine months ended September 30, 2017 to $5.2 million for the same period in 2018.2019. The increasedecrease for the three and ninesix month period was due primarily related to increased transaction volume.a lower volume of insufficient funds and return item charges. 

 

The Company originates residential mortgage loans and utilizes both “mandatory delivery” and “best efforts” forward loan sale commitments to sell those loans, servicing released. Sales of residential mortgage loans yielded gains of $1.4 million for the three months ended September 30, 2018 compared to $1.8 million in the same period in 2017. Sales of residential mortgage loans yielded gains of $4.3 million for the nine months ended September 30, 2018 compared to $6.1 million in the same period in 2017. Loans sold are subject to repurchase in circumstances where documentation is deficient or the underlying loan becomes delinquent or pays off within a specified period following loan funding and sale. The Bank considers these potential recourse provisions to be a minimal risk, but has established a reserve under generally accepted accounting principles for possible repurchases. There were no repurchases due to fraud by the borrower during the three months ended SeptemberJune 30, 2018.2019. The reserve amounted to $55$54 thousand at SeptemberJune 30, 20182019 and is included in other liabilities on the Consolidated Balance Sheets. The Bank does not originate “sub-prime” loans and has no exposure to this market segment.

 

The Company is an originator of SBA loans and its practice is to sell the guaranteed portion of those loans at a premium. Income from this source was $73$16 thousand for the three months ended SeptemberJune 30, 20182019 compared to $390$130 thousand for the same period in 2017.2018. Income from this source was $373$124 thousand for the ninesix months ended SeptemberJune 30, 20182019 compared to $626$300 thousand for the same period in 2017.2018. Activity in SBA loan sales to secondary markets can vary widely from quarter to quarter.

 


Other income totaled $2.0$1.8 million for the three months ended SeptemberJune 30, 20182019 as compared to $2.6$1.7 million for the same period in 2017, a decrease2018, an increase of 23%6%. ATM fees increaseddecreased slightly to $363$368 thousand for the three months ended SeptemberJune 30, 20182019 from $350$373 thousand for the same period in 2017, an increase2018, a decrease of less than 1%. Noninterest fee income totaled $545$471 thousand for the three months ended SeptemberJune 30, 2018 a decrease2019 an increase of $802$40 thousand, or 60%9%, over the total for the same period in 2017 primarily due to $779 thousand of gains on the origination, securitization, servicing, and sale of FHA Multifamily-Backed Ginnie Mae securities in the third quarter of 2017 compared to insignificant revenue for the same period of 2018.

52 

 

Other income totaled $5.5$3.7 million for the ninesix months ended SeptemberJune 30, 20182019 as compared to $6.8$3.5 million for the same period in 2017,2018, an increase of 6%. ATM fees decreased to $681 thousand for the six months ended June 30, 2019 from $728 thousand for the same period in 2018, a decrease of 19%6%. ATM fees totaled $1.1 million for both the nine months ended September 30, 2018 and 2017. Noninterest fee income totaled $1.4 million$946 thousand for the ninesix months ended SeptemberJune 30, 2018 a decrease2019 an increase of $1.6 million,$72 thousand, or 53%8%, over the total for the same period in 2017 primarily due to $1.5 million of gains on the origination, securitization, servicing, and sale of FHA Multifamily-Backed Ginnie Mae securities in the first nine months of 2017 compared to insignificant revenue for the same period of 2018. EagleBank received approval as a Ginnie Mae Issuer of Ginnie Mae I multifamily mortgage-backed securities during May 2017. Activity in FHA Multifamily-backed Ginnie Mae securities can vary widely.

 

Net investment gains were $68$563 thousand for the ninethree months ended SeptemberJune 30, 20182019 compared to $542$26 thousand for the same period in 2017.2018. Net investment gains were $1.5 million for the six months ended June 30, 2019 compared to $68 thousand for the same period in 2018 primarily due to $829 thousand of noninterest income recognized during March 2019 on interest rate swap terminations.

 

Noninterest Expense

 

Total noninterest expense includes salaries and employee benefits, premises and equipment expenses, marketing and advertising, data processing, FDIC insurance, and other expenses.

 

Total noninterest expenses totaled $31.6$33.4 million for the three months ended SeptemberJune 30, 2018,2019, as compared to $29.5$32.3 million for the three months ended SeptemberJune 30, 2017,2018, a 7%3% increase. Total noninterest expenses totaled $95.0$71.7 million for the ninesix months ended SeptemberJune 30, 2018,2019, as compared to $88.7$63.4 million for the ninesix months ended SeptemberJune 30, 2017,2018, a 7%13% increase.

 

Salaries and employee benefits were $17.2$17.7 million for the three months ended SeptemberJune 30, 2018,2019, as compared to $16.9$17.8 million for the same period in 2017,2018, a decrease of less than 1% increase. Salaries and benefits cost increases for the three month period were due primarily to merit increases and larger staff partially offset by lower incentive compensation accruals.. Salaries and employee benefits were $51.8$41.4 million for the ninesix months ended SeptemberJune 30, 2018,2019, as compared to $50.5$34.7 million for the same period in 2017, a 3% increase. Salaries and benefits cost increases for the nine month period were2018, an increase of 19% due primarily to $6.2 million of nonrecurring charges related to share based compensation and the retirement of our former Chairman and Chief Executive Officer, Mr. Ronald D. Paul and secondly to increased staff and merit increases. overall headcount.

At SeptemberJune 30, 2018,2019, the Company’s full time equivalent staff numbered 478,496, as compared to 466470 at December 31, 2017,2018, and 471479 at SeptemberJune 30, 2017.2018.

 

Premises and equipment expenses amounted to $3.7 million and $3.9 million for the three month periodmonths ended SeptemberJune 30, 2019 and 2018, and $3.8 million for the same period in 2017,respectively, a 1% increase. Premises and equipment expenses amounted to $11.7 million for the nine month period ended September 30, 2018 and $11.6 million for the same period in 2017, a 1% increase.6% decrease. For the three months ended SeptemberJune 30, 2018,2019, the Company recognized $123$126 thousand of sublease revenue as compared to $143$123 thousand for the same period in 2017.2018. Premises and equipment expenses amounted to $7.5 million and $7.8 million for the six month periods ended June 30, 2019 and 2018, respectively, a 4% decrease. For the ninesix months ended SeptemberJune 30, 2018,2019, the Company recognized $379$251 thousand of sublease revenue as compared to $365$256 thousand for the same period in 2017.2018. Sublease revenue is accounted for as a reduction to premises and equipment expenses.

 

Marketing and advertising expenses increased to $1.2were $1.3 million for both the three months ended SeptemberJune 30, 2018 from $732 thousand for the same period in 2017, a 63% increase.2019 and June 30, 2018. Marketing and advertising expenses increased to $3.4$2.4 million for the ninesix months ended SeptemberJune 30, 20182019 from $2.9$2.2 million for the same period in 2017, a 19% increase. The2018, an 8% increase, in the three and nine month periods was primarily due to printincreased digital, radio and digital advertising.television advertising spend.

 

Data processing expense increased to $2.4$2.6 million for the three months ended SeptemberJune 30, 20182019 from $2.0$2.4 million for the same period in 2017, a 20% increase.2018, an 8% increase, due primarily to costs of software and infrastructure investments. Data processing expense increased to $7.1$5.0 million for the ninesix months ended SeptemberJune 30, 2018,2019 from $6.1$4.7 million for the same period in 2017, an 18% increase. The2018, a 5% increase, in the three and nine month periods wasdue primarily due to the costs of software and infrastructure investments.

 


Legal,During the three month periods ended June 30, 2019 and June 30, 2018, the Company incurred legal, accounting and professional fees and expenses of $2.7 million and $2.2 million, respectively, which represented an increase of 26%. For the six month periods ended June 30, 2019 and June 30, 2018, the Company incurred legal, accounting and professional fees and expenses of $4.4 million and $5.2 million, respectively, which represented a decrease of 14%. During the three months ended June 30, 2018, these expenses related substantially to the Company’s engagement of independent accounting, legal and compliance consultants who conducted various investigations for the Company, in addition to consulting costs to enhance our governance and risk management systems. During the three months ended June 30, 2019, such expenses related primarily to legal fees and expenditures in connection with our responses to investigations and related document requests and subpoenas from government agencies examining matters, including the Company’s identification, classification and disclosure of related party transactions; the retirement of certain former officers and directors; and the relationship of the Company and certain of its former officers and directors with a local public official. The Company has D&O insurance that may provide reimbursement for all or part of advancement and indemnification costs requested by current and former officers and directors, and those costs cannot be estimated at this time. While we are unable to estimate the amount of these legal expenditures at this time, the Company expects that it will continue to incur elevated levels of legal and professional fees and expenses for at least the remainder of 2019 as it continues to cooperate with these investigations. Other than these increased costs, we do not believe at this time that the resolution of these investigations will be materially adverse to the Company. As a result of these ongoing investigations, there have been no regulatory restrictions placed on the Company’s ability to fully engage in its banking business as presently conducted. We are, however, unable to predict the duration, scope or outcome of these investigations.

FDIC insurance increased to $2.1$1.1 million for the three months ended SeptemberJune 30, 2019 from $951 thousand for the same period in 2018, an 18% increase. FDIC insurance increased to $2.2 million for the six months ended June 30, 2019 from $1.2$1.6 million for the same period in 2017,2018, a 72% increase. The increase in expense for the three month period was due substantially to advisory services associated with enhancing our risk management systems including corporate governance as we approach $10 billion in assets. Legal, accounting and professional fees increased to $7.3 million for the nine months ended September 30, 2018 from $3.5 million in the same period in 2017, a 106% increase. The increase in expense for the nine month period was due substantially to both first and second quarter due diligence costs from independent consultants associated with the internet event late in 2017 as well as costs to enhance risk management systems, including corporate governance as we approach $10 billion in assets.

53 

FDIC insurance increased to $933 thousand for the three months ended September 30, 2018 from $929 thousand for the same period in 2017, an increase of less than 1%. FDIC insurance increased to $2.6 million for the nine months ended September 30, 2018 from $2.1 million for the same period in 2017, a 24%38% increase. The increase for the ninethree and six month period was primarily due to a higher assessment base resulting from growth in total assets.and factors.

 

Other expenses increased to $3.9$4.2 million for the three months ended SeptemberJune 30, 20182019 from $3.8 million for the same period in 2017,2018, an increase of 1%.12%, due primarily to $354 thousand higher real estate and utility costs on special assets. The major components of cost in this category include broker fees, franchise taxes, core deposit intangible amortization, and insurance expense.

Other expenses decreasedincreased to $11.1$8.7 million for the ninesix months ended SeptemberJune 30, 20182019 from $12.2$7.2 million for the same period in 2017, a decrease2018, an increase of 9%20%, due primarily to a $361 thousand net lossbroker fees ($554 thousand) and real estate and utility costs on the sale of OREO in the first quarter of 2017 and a $377 thousand decrease in costs associated with problem loans.special assets ($369 thousand).

 

The efficiency ratio, which measures the ratio of noninterest expense to total revenue, improved to 36.37%was 38.04% for the thirdsecond quarter of 2018 from 37.49%2019, as compared to 38.55% for the thirdsecond quarter of 2017. The2018. For the first six months of 2019, the efficiency ratio improvedwas 40.95% as compared to 37.74% for the nine months ended September 30, 2018 from 38.86%38.47% for the same period in 2017. 2018.

As a percentage of average assets, total noninterest expense (annualized) improved to 1.58%was 1.55% for the three months ended SeptemberJune 30, 20182019 as compared to 1.66% for the same period in 2017.2018. As a percentage of average assets, total noninterest expense (annualized) improved to 1.62%was 1.68% for the ninesix months ended SeptemberJune 30, 20182019 as compared to 1.70%1.65% for the same period in 2017.2018.

 

Income Tax Expense

 

The Company’s ratio of income tax expense to pre-tax income (“effective tax rate”) decreasedincreased to 26.3%26.6% and 25.7%26.3% for the three and ninesix months ended SeptemberJune 30, 2018,2019, respectively, as compared to 36.8%25.1% and 37.2%25.4%, respectively, for the same periodsperiod in 2017.2018. The lowerhigher effective tax rate for the three and ninesix months ended SeptemberJune 30, 2018, were2019, was due largelyprimarily to a reductiondecrease in the federal corporate tax rate from 35% to 21% pursuant to The Tax Cutscredits and Jobs Act of 2017 and a $515 thousand tax true-up recorded during the third quarter of 2018.an increase in nondeductible expenses.

 

FINANCIAL CONDITION

 

Summary

 

Total assets at SeptemberJune 30, 20182019 were $8.06$8.67 billion, an 8%a 3% increase as compared to $7.48$8.39 billion at December 31, 2017.2018. Total loans (excluding loans held for sale) were $6.84$7.39 billion at SeptemberJune 30, 2018,2019, a 7%6% increase as compared to $6.41$6.99 billion at December 31, 2017.2018. Loans held for sale amounted to $18.7$37.5 million at SeptemberJune 30, 20182019 as compared to $25.1$19.3 million at December 31, 2017,2018, a 25% decrease.95% increase. The investment portfolio totaled $722.7$745.3 million at SeptemberJune 30, 2018,2019, a 23% increase5% decrease from the $589.3$784.1 million balance at December 31, 2017.2018.

 


Total deposits at SeptemberJune 30, 20182019 were $6.37$6.95 billion, a slight decrease compared to deposits of $5.85$6.97 billion at December 31, 2017, a 9% increase.2018. Total borrowed funds (excluding customer repurchase agreements) were $542.2$442.5 million at SeptemberJune 30, 2018 and $541.9 million at December 31, 2017,2019, of which $325.0$225.0 million were FHLB advances as of September 30, 2018.that subsequently matured in July 2019. The Company had $217.3 million in FHLB advances outstanding totaling $125.0 million as of September 30, 2018 will mature in March 2019 and the remaining $200.0 million will mature in June 2019.at December 31, 2018. We continue to work on expanding the breadth and depth of our existing deposit relationships while we continue to pursue building new relationships.

 

Total shareholders’ equity at SeptemberJune 30, 20182019 increased 12%7%, from $950.4 million$1.11 billion at December 31, 2017. The increase in shareholders’ equity at September 30, 2018 compared to the year end 2017 was primarily as the result of growth in retained earnings. The Company’s capital position remains substantially in excess of regulatory requirements for well capitalized status, with a total risk based capital ratio of 15.74%16.36% at SeptemberJune 30, 2018, as compared to 15.30% at September 30, 2017,2019 and 15.02%16.08% at December 31, 2017.2018. In addition, the tangible common equity ratio was 12.01%12.60% at SeptemberJune 30, 2018,2019 compared to 11.35% at September 30, 2017 and 11.44%12.11% at December 31, 2017.2018. Tangible book value per share was $31.25 at June 30, 2019, a 7% increase over $29.17 at December 31, 2018. Partly as a result of our strong capital position, the Company reinstituted a quarterly cash dividend in the second quarter of 2019. A $0.22 per share dividend was declared May 15th to shareholders of record on May 31st and was paid June 14, 2019.

54 

 

Under the capital rules applicable to the Company and Bank, in order to be considered well-capitalized, the Bank must have a common equity Tier 1 risk based capital (“CET1”) ratio of 6.5%, a Tier 1 risk-based ratio of 8.0%, a total risk-based capital ratio of 10.0% and a leverage ratio of 5.0%. The Company and the Bank meet all these requirements, and satisfy the requirement to maintain the fully phased in capital conservation buffer of 2.5% of common equity tier 1 capital for capital adequacy purposes. Beginning in 2016, failureFailure to maintain the required capital conservation buffer would limit the ability of the Company and the Bank to pay dividends, repurchase shares or pay discretionary bonuses.

 

Loans, net of amortized deferred fees and costs, at SeptemberJune 30, 20182019 and December 31, 20172018 by major category are summarized below.

 

  September 30, 2018  December 31, 2017 
(dollars in thousands) Amount  %  Amount  % 
Commercial $1,493,577   22% $1,375,939   21%
Income producing - commercial real estate  3,189,910   46%  3,047,094   48%
Owner occupied - commercial real estate  863,162   13%  755,444   12%
Real estate mortgage - residential  104,864   2%  104,357   2%
Construction - commercial and residential  1,047,591   15%  973,141   15%
Construction - C&I (owner occupied)  56,572   1%  58,691   1%
Home equity  86,525   1%  93,264   1%
Other consumer  2,471   —   3,598   — 
Total loans  6,844,672   100%  6,411,528   100%
Less: allowance for credit losses  (68,189)      (64,758)    
Net loans $6,776,483      $6,346,770     

  June 30, 2019  December 31, 2018 
(dollars in thousands) Amount�� %  Amount  % 
Commercial $1,475,201   20% $1,553,112   22%
Income producing - commercial real estate  3,666,815   50%  3,256,900   46%
Owner occupied - commercial real estate  970,850   13%  887,814   13%
Real estate mortgage - residential  105,191   1%  106,418   2%
Construction - commercial and residential  1,012,789   14%  1,039,815   15%
Construction - C&I (owner occupied)  76,324   1%  57,797   1%
Home equity  83,447   1%  86,603   1%
Other consumer  1,998   —   2,988   — 
    Total loans  7,392,615   100%  6,991,447   100%
Less: allowance for credit losses  (72,086)      (69,944)    
   Net loans $7,320,529      $6,921,503     

 

In its lending activities, the Company seeks to develop and expand relationships with clients whose businesses and individual banking needs will grow with the Bank. Superior customer service, local decision making, and accelerated turnaround time from application to closing have been significant factors in growing the loan portfolio, and meeting the lending needs in the markets served, while maintaining sound asset quality.

 

Loans outstanding reached $6.84$7.39 billion at SeptemberJune 30, 2018,2019, an increase of $433.1$401.2 million, or 7%6%, as compared to $6.41$6.99 billion at December 31, 2017.2018. Loan growth during the ninesix months ended SeptemberJune 30, 20182019 was predominantly in the income producing – commercial real estate commercial, and owner occupied – commercial real estate loan categories. Despite an increased level of in-market competition for business, the Bank continued to experience organic loan growth across the portfolio. Notwithstanding increased supply of units, multi-family commercial real estate leasing in the Bank’s market area has held up well, particularly for well-located close-in projects. While as a general comment there has been some softening in the Suburban Maryland office leasing market, in certain well located pockets and submarkets, the sector has softened, but we continue to find that, as with many aspects of the real estate market, the actual success of any particular building is largely dependent on specific locational attributes.evidenced some positive absorption. Overall, commercial real estate values have generally held up well with price escalation in prime pockets, but we continue to be cautious of the cap rates at which some assets are trading and we are being careful with valuations as a result. TheWhile the high-end real estate market has softened, the moderately priced housing market has remained stable to increasing, with well-located, Metro accessible properties garnering a premium.

 


Deposits and Other Borrowings

 

The principal sources of funds for the Bank are core deposits, consisting of demand deposits, money market accounts, NOW accounts, savings accounts and certificates of deposit. The deposit base includes transaction accounts, time and savings accounts and accounts which customers use for cash management and which provide the Bank with a source of fee income and cross-marketing opportunities, as well as an attractive source of lower cost funds. To meet funding needs during periods of high loan demand and seasonal variations in core deposits, the Bank utilizes alternative funding sources such as secured borrowings from the FHLB, federal funds purchased lines of credit from correspondent banks and brokered deposits from regional and national brokerage firms and Promontory Interfinancial Network, LLC (“Promontory”).

 

For the ninesix months ended SeptemberJune 30, 2018,2019, noninterest bearing deposits increased $75.0decreased $230.3 million as compared to December 31, 2017,2018, while interest bearing deposits increased by $443.3$205.9 million during the same period. Average total deposits for the first nine months of 2018 were $6.27 billion, as compared to $5.68 billion for the same period in 2017, a 10% increase.

55 

 

From time to time, when appropriate in order to fund strong loan demand, the Bank accepts brokered time deposits, generally in denominations of less than $250 thousand, from a regional brokerage firm, and other national brokerage networks, including Promontory. Additionally, the Bank participates in the Certificates of Deposit Account Registry Service (“CDARS”) and the Insured Cash Sweep product (“ICS”), which provides for reciprocal (“two-way”) transactions among banks facilitated by Promontory for the purpose of maximizing FDIC insurance. The Bank also is able to obtain one-way CDARS deposits and participates in Promontory’s Insured Network Deposit (“IND”). At SeptemberJune 30, 2018,2019, total deposits included $1.08$1.71 billion of brokered deposits (excluding the CDARS and ICS two-way), which represented 17%25% of total deposits. At December 31, 2017,2018, total brokered deposits (excluding the CDARS and ICS two-way) were $865.5 million,$1.36 billion, or 15%20% of total deposits. The CDARS and ICS two-way component represented $550.7$517.3 million, or 9%7% of total deposits and $574.4$391.7 million or 10%6% of total deposits at SeptemberJune 30, 20182019 and December 31, 2017,2018, respectively. These sources are believed by the Company to represent a reliable and cost efficient alternative funding source for the Bank. However, to the extent that the condition or reputation of the Company or Bank deteriorates, or to the extent that there are significant changes in market interest rates which the Company and Bank do not elect to match, we may experience an outflow of brokered deposits. In that event we would be required to obtain alternate sources for funding.

 

At SeptemberJune 30, 20182019 the Company had $2.06$1.87 billion in noninterest bearing demand deposits, representing 32%27% of total deposits, compared to $1.98$2.10 billion of noninterest bearing demand deposits at December 31, 2017,2018, or 34%30% of total deposits. Average noninterest bearing deposits were 33%32% of total deposits for the first ninesix months of 20182019 and 32%33% for the first ninesix months of 2017.2018. The Bank also offers business NOW accounts and business savings accounts to accommodate those customers who may have excess short term cash to deploy in interest earning assets.

 

As an enhancement to the basic noninterest bearing demand deposit account, the Company offers a sweep account, or “customer repurchase agreement,” allowing qualifying businesses to earn interest on short-term excess funds which are not suited for either a certificate of deposit or a money market account. The balances in these accounts were $36.4$31.7 million at SeptemberJune 30, 20182019 compared to $76.6$30.4 million at December 31, 2017.2018. Customer repurchase agreements are not deposits and are not insured by the FDIC, but are collateralized by U.S. agency securities and/or U.S. agency backed mortgage backed securities. These accounts are particularly suitable to businesses with significant fluctuation in the levels of cash flows. Attorney and title company escrow accounts are examples of accounts which can benefit from this product, as are customers who may require collateral for deposits in excess of FDIC insurance limits but do not qualify for other pledging arrangements. This program requires the Company to maintain a sufficient investment securities level to accommodate the fluctuations in balances which may occur in these accounts.

 

At SeptemberJune 30, 20182019 the Company had $1.28$1.50 billion in time deposits. Time deposits increased by $130.1$173.9 million from periodyear end June 30, 2018 to September 30,December 31, 2018. AverageThe Bank raises and renews time deposits grew by $97.4 million inthrough its branch network, for its public funds customers, and through brokered CDs to meet the third quarterneeds of its community of savers and as compared to the second quarter. A targeted effort to raise more time deposits in the third quarter resulted in this growth. Time deposits serve as an important part of the Company’s funding mixits interest rate risk management and became more of a focus starting in the second quarter of 2018.liquidity planning.

 

The Company had no outstanding balances under its federal funds lines of credit provided by correspondent banks (which are unsecured) at SeptemberJune 30, 20182019 and December 31, 2017.2018. The Bank had $325.0$225.0 million in short-term borrowings outstanding under its credit facility from the FHLB at both SeptemberJune 30, 2018 and2019. The Bank did not have short-term borrowings outstanding at December 31, 2017.2018. Outstanding FHLB advances are secured by collateral consisting of a blanket lien on qualifying loans in the Bank’s commercial mortgage, residential mortgage and home equity loan portfolios.

 


Long-term borrowings outstanding at SeptemberJune 30, 20182019 included the Company’s August 5, 2014 issuance of $70.0 million of subordinated notes, due September 1, 2024 and the Company’s July 26, 2016 issuance of $150.0 million of subordinated notes, due August 1, 2026. For additional information on the subordinated notes, please refer to Note 810 to the Consolidated Financial Statements included in this report.

56 

 

Liquidity Management

 

Liquidity is a measure of the Company’s and Bank’s ability to meet loan demand and to satisfy depositor withdrawal requirements in an orderly manner. The Bank’s primary sources of liquidity consist of cash and cash balances due from correspondent banks, excess reserves at the Federal Reserve, loan repayments, federal funds sold and other short-term investments, maturities and sales of investment securities, income from operations and new core deposits into the Bank. The Bank’s investment portfolio of debt securities is held in an available-for-sale status which allows for flexibility, subject to holdings held as collateral for customer repurchase agreements, and public funds, to generate cash from sales as needed to meet ongoing loan demand. These sources of liquidity are considered primary and are supplemented by the ability of the Company and Bank to borrow funds or issue brokered deposits, which are termed secondary sources of liquidity and which are substantial. Additionally, the Bank can purchase up to $147.5$172.5 million in federal funds on an unsecured basis from its correspondents, against which there was no amount outstanding at SeptemberJune 30, 2018,2019, and can obtain unsecured funds under one-way CDARS and ICS brokered deposits in the amount of $1.21$1.30 billion, against which there was $192.5$181.4 million outstanding at SeptemberJune 30, 2018.2019. The Bank also has a commitment from Promontory to place up to $700.0 million of brokered deposits from its IND program in amounts requested by the Bank, as compared to an actual balance of $291.7$407.3 million at SeptemberJune 30, 2018.2019. At SeptemberJune 30, 20182019 the Bank was also eligible to make advances from the FHLB up to $1.4$1.6 billion based on collateral at the FHLB, of which there was $325.0$225 million outstanding at SeptemberJune 30, 2018.2019. The Bank may enter into repurchase agreements as well as obtain additional borrowing capabilities from the FHLB provided adequate collateral exists to secure these lending relationships. The Bank also has a back-up borrowing facility through the Discount Window at the Federal Reserve Bank of Richmond (“Federal Reserve Bank”). This facility, which amounts to approximately $598.0$661.0 million, is collateralized with specific loan assets identified to the Federal Reserve Bank. It is anticipated that, except for periodic testing, this facility would be utilized for contingency funding only.

 

The loss of deposits, through disintermediation, is one of the greater risks to liquidity. Disintermediation occurs most commonly when rates rise and depositors withdraw deposits seeking higher rates in alternative savings and investment sources than the Bank may offer. The Bank was founded under a philosophy of relationship banking and, therefore, believes that it has less of an exposure to disintermediation and resultant liquidity concerns than do many banks. The Bank makes competitive deposit interest rate comparisons weekly and feels its interest rate offerings are competitive. There is, however, a risk that some deposits would be lost if rates were to increase and the Bank elected not to remain competitive with its deposit rates. Under those conditions, the Bank believes that it is well positioned to use other sources of funds such as FHLB borrowings, brokered deposits, repurchase agreements and correspondent banks’ lines of credit to offset a decline in deposits in the short run. Over the long-term, an adjustment in assets and change in business emphasis could compensate for a potential loss of deposits. The Bank also maintains a marketable investment portfolio to provide flexibility in the event of significant liquidity needs. The Asset Liability Committee of the Bank’sBank (“ALCO”) and the full Board of Directors (“ALCO”) hasof the Bank have adopted policy guidelines which emphasize the importance of core deposits, adequate asset liquidity and a contingency funding plan.

 

At SeptemberJune 30, 2018,2019, under the Bank’s liquidity formula, it had $3.91$4.26 billion of primary and secondary liquidity sources. The amount is deemed adequate to meet current and projected funding needs.

 

54

Commitments and Contractual Obligations

 

Loan commitments outstanding and lines and letters of credit at SeptemberJune 30, 20182019 are as follows:

 

(dollars in thousands)    2019 
Unfunded loan commitments $2,202,589  $2,398,984 
Unfunded lines of credit  91,747   90,902 
Letters of credit  77,577   78,525 
Total $2,371,913  $2,568,411 

 

Unfunded loan commitments are agreements whereby the Bank has made a commitment and the borrower has accepted the commitment to lend to a customer as long as there is satisfaction of the terms or conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee before the commitment period is extended. In many instances, borrowers are required to meet performance milestones in order to draw on a commitment as is the case in construction loans, or to have a required level of collateral in order to draw on a commitment, as is the case in asset based lending credit facilities. Since commitments may expire without being drawn, the total commitment amount does not necessarily represent future cash requirements. As of SeptemberJune 30, 2018,2019, unfunded loan commitments included $36.5$103.4 million related to interest rate lock commitments on residential mortgage loans and were of a short-term nature.

57 

 

Unfunded lines of credit are agreements to lend to a customer as long as there is no violation of the terms or conditions established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since commitments may expire without being drawn, the total commitment amount does not necessarily represent future cash requirements.

 

Letters of credit include standby and commercial letters of credit. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance by the Bank’s customer to a third party. Standby letters of credit generally become payable upon the failure of the customer to perform according to the terms of the underlying contract with the third party. Standby letters of credit are generally not drawn. Commercial letters of credit are issued specifically to facilitate commerce and typically result in the commitment being drawn when the underlying transaction is consummated between the customer and a third party. The contractual amount of these letters of credit represents the maximum potential future payments guaranteed by the Bank. The Bank has recourse against the customer for any amount it is required to pay to a third party under a letter of credit, and holds cash and or other collateral on those standby letters of credit for which collateral is deemed necessary.

 

Asset/Liability Management and Quantitative and Qualitative Disclosures about Market Risk

 

A fundamental risk in banking is exposure to market risk, or interest rate risk, since a bank’s net income is largely dependent on net interest income. The Bank’s ALCO formulates and monitors the management of interest rate risk through policies and guidelines established by it and the full Board of Directors and through review of detailed reports discussed quarterly. In its consideration of risk limits, the ALCO considers the impact on earnings and capital, the level and direction of interest rates, liquidity, local economic conditions, outside threats and other factors. Banking is generally a business of managing the maturity and re-pricing mismatch inherent in its asset and liability cash flows and to provide net interest income growth consistent with the Company’s profit objectives.

 

During the three months ended SeptemberJune 30, 2018,2019, as compared to the same period in 2017,2018, the Company was able to increase its net interest income by 13%4%, produce a net interest margin of 4.14%3.91%, which equaled the 4.14% net interest margin for the same period in 2017, and continue to manage its overall interest rate risk position.

 

The Company, through its ALCO and ongoing financial management practices, monitors the interest rate environment in which it operates and adjusts the rates and maturities of its assets and liabilities to remain competitive and to achieve its overall financial objectives subject to established risk limits. In the current and expected future interest rate environment, the Company has been maintaining its investment portfolio to manage the balance between yield and prepayment risk in its portfolio of mortgage backed securities should interest rates remain at current levels. Further, the Company has been managing the investment portfolio to mitigate extension risk and related declines in market values in that same portfolio should interest rates increase. Additionally, the Company has limited call risk in its U.S. agency investment portfolio. During the three months ended SeptemberJune 30, 2018,2019, the average investment portfolio balances increased as compared to balances at SeptemberJune 30, 2017.2018, but decreased from December 31, 2018. The cash received from deposit growth along with cash flows off offrom the investment portfolio were deployed into loans and the purchase of additionalreplacement investments.

 


The percentage mix of municipal securities was 6%9% of total investments at SeptemberJune 30, 20182019 and 11%8% at SeptemberJune 30, 2017, the2018. The portion of the portfolio invested in mortgage backed securities increased to 72%was 69% at Septemberboth June 30, 2018 from 63% at September2019 and June 30, 2017.2018. The portion of the portfolio invested in U.S. agency investments was 21%20% at SeptemberJune 30, 20182019 and 24%23% at SeptemberJune 30, 2017.2018. Shorter duration floating rate corporate bonds were 1% and 2% of total investments at Septemberboth June 30, 20182019 and SeptemberJune 30, 2017, respectively,2018, and SBA bonds, which are included in mortgage backed securities, were 11% and 9%10% of total investments at Septemberboth June 30, 20182019 and SeptemberJune 30, 2017, respectively. Even2018. Over the past 12 months, as the bond portfolio rolled forward, the purchasea result of longer duration instruments combined with slowergenerally lower interest rates, mortgage prepayment of mortgage backed security principal, led tospeeds increased and the duration of the investment portfolio increasingdecreased to only 3.93.0 years at SeptemberJune 30, 20182019 from 3.53.8 years at SeptemberJune 30, 2017, as the Bank was able to earn higher yields in the bond market.2018.

 

The re-pricing duration of the loan portfolio was 1619 months at SeptemberJune 30, 20182019 versus 2217 months at September 30, 2017,December 31, 2018, with fixed rate loans amounting to 36%40% and 34% of total loans at SeptemberJune 30, 20182019 and SeptemberJune 30, 2017,2018, respectively. Variable and adjustable rate loans comprised 64%60% and 66% of total loans at SeptemberJune 30, 20182019 and SeptemberJune 30, 2017,2018, respectively. Variable rate loans are generally indexed to either the one month LIBOR interest rate, or the Wall Street Journal prime interest rate, while adjustable rate loans are indexed primarily to the five year U.S. Treasury interest rate.

 

58 

The duration of the deposit portfolio increased to 2728 months at SeptemberJune 30, 20182019 from 26 months at September 30, 2017.December 31, 2018. The change since September 30, 2017December 31, 2018 was due substantially to a change in the mix and duration of money markettime deposits as marketmarkets interest rates increased.decreased and customers anticipated continuing rate declines. Additionally, the Bank maintained a higher mixpercentage of fixed rate time deposits at June 30, 2019 than was obtainedthe case in the six month period ended September 30,December 31, 2018.

 

The Company has continued its emphasis on funding loans in its marketplace, and has been able to achieve favorable loan pricing, although competition for new loans persists. A disciplined approach to loan pricing, with variable and adjustable rate loans comprising 64%60% of total loans (at SeptemberJune 30, 2018)2019), has resulted in a loan portfolio yield of 5.69%5.61% for the three months ended SeptemberJune 30, 20182019 as compared to 5.19%5.53% for the same period in 2017.2018. Variable and adjustable rate loans provide additional income opportunities should interest rates rise from current levels.

 

The net unrealized lossgain before income tax on the investment portfolio was $18.9$5.2 million at SeptemberJune 30, 20182019 as compared to a net unrealized loss before tax of $5.1$9.5 million at December 31, 2017.2018. The increase in the net unrealized lossgain on the investment portfolio at SeptemberJune 30, 20182019 as compared to December 31, 20172018 was due primarily to the higherlower interest rates at SeptemberJune 30, 2018.2019. At SeptemberJune 30, 2018,2019, the net unrealized lossgain position represented -2.6%0.7% of the investment portfolio’s book value.

 

There can be no assurance that the Company will be able to successfully achieve its optimal asset liability mix, as a result of competitive pressures, customer preferences and the inability to perfectly forecast future interest rates and movements.

 

One of the tools used by the Company to manage its interest rate risk is a static GAP analysis presented below. The Company also employs an earnings simulation model on a quarterly basis to monitor its interest rate sensitivity and risk and to model its balance sheet cash flows and the related income statement effects in different interest rate scenarios. The model utilizes current balance sheet data and attributes and is adjusted for assumptions as to investment maturities (including prepayments), loan prepayments, interest rates, and the level of noninterest income and noninterest expense. The data is then subjected to a “shock test” which assumes a simultaneous change in interest rates up 100, 200, 300, and 400 basis points or down 100 and 200, along the entire yield curve, but not below zero. The results are analyzed as to the impact on net interest income, net income and the market equity over the next twelve and twenty-four month periods from SeptemberJune 30, 2018.2019. In addition to analysis of simultaneous changes in interest rates along the yield curve, changes based on interest rate “ramps” is also performed. This analysis represents the impact of a more gradual change in interest rates, as well as yield curve shape changes.

 

For the analysis presented below, at SeptemberJune 30, 2018,2019, the simulation assumes a 50 basis point change in interest rates on money market and interest bearing transaction deposits for each 100 basis point change in market interest rates in a decreasing interest rate shock scenario with a floor of 10 basis points, and assumes a 70 basis point change in interest rates on money market and interest bearing transaction deposits for each 100 basis point change in market interest rates in an increasing interest rate shock scenario.

 


As quantified in the table below, the Company’s analysis at SeptemberJune 30, 20182019 shows a moderate effect on net interest income (over the next 12 months) as well as a moderate effect on the economic value of equity when interest rates are shocked both down 100 and 200 basis points and up 100, 200, 300, and 400 basis points. This moderate impact is due substantially to the significant level of variable rate and re-priceable assets and liabilities and related shorter relative durations. The re-pricing duration of the investment portfolio at SeptemberJune 30, 20182019 is 3.93.0 years, the loan portfolio 1.31.6 years, the interest bearing deposit portfolio 2.3 years, and the borrowed funds portfolio 1.61.5 years.

59 

 

The following table reflects the result of simulation analysis on the SeptemberJune 30, 20182019 asset and liabilities balances:

 

Change in interest rates (basis points) Percentage change in net interest income Percentage change in net income Percentage change in market value of portfolio equity Percentage change in
net interest income		 Percentage change in
net income		 Percentage change in
market value of
portfolio equity
       
+400 +21.4% +36.4%  +7.8% +16.6% +28.8% +3.9%
+300 +16.1% +27.3% +6.0% +12.5% +21.6% +3.6%
+200 +10.8% +18.3% +4.4% +8.4% +14.5% +3.1%
+100 +5.4% +9.2% +2.5% +4.2% +7.3% +2.0%
0 —  —  —  — — —
-100 -4.4% -7.4% -3.8% -3.8% -6.6% -3.0%
-200 -6.0% -10.3% -8.6% -5.7% -9.9% -7.7%

 

The results of simulation are within the policy limits adopted by the Company. For net interest income, the Company has adopted a policy limit of -10% for a 100 basis point change, -12% for a 200 basis point change, -18% for a 300 basis point change and -24% for a 400 basis point change. For the market value of equity, the Company has adopted a policy limit of -12% for a 100 basis point change, -15% for a 200 basis point change, -25% for a 300 basis point change and -30% for a 400 basis point change. The changes in net interest income, net income and the economic value of equity in both a higher and lower interest rate shock scenario at SeptemberJune 30, 20182019 are not considered to be excessive. The positive impact of +5.4%+4.2% in net interest income and +9.2%+7.3% in net income given a 100 basis point increase in market interest rates reflects in large measure the impact of variable rate loans and fed funds sold repricing counteracting the repricing of interest bearing deposits and floating rate FHLB advances.

 

In the thirdsecond quarter of 2018,2019, the Company continued to manage its interest rate sensitivity position to moderate levels of risk, as indicated in the simulation results above. The interest rate risk position at SeptemberJune 30, 20182019 was similar to the interest rate risk position at December 31, 2017.2018.

 

Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or repricing periods, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate mortgage loans, have features that limit changes in interest rates on a short-term basis and over the life of the loan. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the tables. Finally, the ability of many borrowers to service their debt may decrease in the event of a significant interest rate increase.

 

During the thirdsecond quarter of 2018,2019, average market interest rates increaseddecreased across the yield curve. Overall, there was a flattening of the yield curve as compared to the thirdsecond quarter of 20172018 with rate increasesdecreases being generally more significant at the frontlonger end of the yield curve.

 

As compared to the thirdsecond quarter of 2017,2018, the average two-year U.S. Treasury rate increaseddecreased by 12234 basis points from 1.36%2.47% to 2.58%2.13%, the average five year U.S. Treasury rate increaseddecreased by 10065 basis points from 1.81%2.77% to 2.81%2.12% and the average ten year U.S. Treasury rate increaseddecreased by 6859 basis points from 2.24%2.92% to 2.92%2.33%. The Company’s net interest margin was 3.91% for both the thirdsecond quarter of 20182019 and 2017 was 4.14%.4.15% 2018. The Company believes that the net interest margin in the most recent quarter as compared to 2017’s third2018’s second quarter has been consistent with its risk analysis at December 31, 2017.2018.

 


GAP Position

 

Banks and other financial institutions earnings are significantly dependent upon net interest income, which is the difference between interest earned on earning assets and interest expense on interest bearing liabilities. This revenue represented 94% and 91%93% of the Company’s revenue for both the thirdsecond quarter of 20182019 and 2017, respectively.2018.

 

In falling interest rate environments, net interest income is maximized with longer term, higher yielding assets being funded by lower yielding short-term funds, or what is referred to as a negative mismatch or GAP. Conversely, in a rising interest rate environment, net interest income is maximized with shorter term, higher yielding assets being funded by longer-term liabilities or what is referred to as a positive mismatch or GAP.

 


The GAP position, which is a measure of the difference in maturity and repricing volume between assets and liabilities, is a means of monitoring the sensitivity of a financial institution to changes in interest rates. The chart below provides an indication of the sensitivity of the Company to changes in interest rates. A negative GAP indicates the degree to which the volume of repriceable liabilities exceeds repriceable assets in given time periods.

 

At SeptemberJune 30, 2018,2019, the Company had a positive GAP position of approximately $860$395 million or 11%5% of total assets out to three months and a positive cumulative GAP position of $613$172 million or 8%2% of total assets out to 12 months; as compared to a positive GAP position of approximately $511$604 million or 7% of total assets out to three months and a positive cumulative GAP position of $442$417 million or 6%5% of total assets out to 12 months at December 31, 2017.2018. The change in the positive GAP position at SeptemberJune 30, 20182019, as compared to December 31, 2017,2018, was due to an increase in the floating rate investment portfolio, a decrease in the amount of customer repurchase agreements, and a slight decrease in the decay rate assumption for noninterest bearing demand account, factors which served to increase the measured repricing GAP as compared with that measure at year end 2017.earning assets. The change in the GAP position at SeptemberJune 30, 20182019 as compared to December 31, 20172018 is not deemed material to the Company’s overall interest rate risk position, which relies more heavily on simulation analysis which captures the full optionality within the balance sheet. The current position is within guideline limits established by the ALCO. While management believes that this overall position creates a reasonable balance in managing its interest rate risk and maximizing its net interest margin within plan objectives, there can be no assurance as to actual results.

 

Management has carefully considered its strategy to maximize interest income by reviewing interest rate levels, economic indicators and call features within its investment portfolio, as well as interest rate floors within its loan portfolio. These factors have been discussed with the ALCO and management believes that current strategies are appropriate to current economic and interest rate trends.

 

If interest rates increase by 100 basis points, the Company’s net interest income and net interest margin are expected to increase modestly due to the impact of significant volumes of variable rate assets together with the assumption of an increase in money market interest rates by 70% of the change in market interest rates.

 

If interest rates decline by 100 basis points, the Company’s net interest income and margin are expected to decline modestly as the impact of lower market rates on a large amount of liquid assets more than offsets the ability to lower interest rates on interest bearing liabilities.

 

Because competitive market behavior does not necessarily track the trend of interest rates but at times moves ahead of financial market influences, the change in the cost of liabilities may be different than anticipated by the GAP model. If this were to occur, the effects of a declining interest rate environment may not be in accordance with management’s expectations.

  


58

GAP Analysis
September 30, 2018
(dollars in thousands)

 

GAP Analysis                 
June 30, 2019                 
(dollars in thousands)                 
                 
                  
Repricible in: 0-3 months  4-12 months  13-36 months  37-60 months  Over 60 months  Total Rate Sensitive  Non Sensitive  Total  0-3 months  4-12 months  13-36 months  37-60 months  Over 60 months  Total Rate Sensitive  Non Sensitive  Total 
RATE SENSITIVE ASSETS:                                                                
Investment securities $87,712  $96,577  $170,482  $153,410  $251,750  $759,931          $185,852  $76,621  $169,361  $121,902  $225,600  $779,336         
Loans (1)(2)  3,858,500   605,300   1,034,069   772,753   592,778   6,863,400           4,003,852   549,180   1,091,962   1,033,287   751,840   7,430,121         
Fed funds and other short-term investments  180,018   —   —   —   —   180,018           189,899   —   —   —   —   189,899         
Other earning assets  73,007   —   —   —   —   73,007           74,295   —   —   —   —   74,295         
Total $4,199,237  $701,877  $1,204,551  $926,163  $844,528  $7,876,356  $181,499  $8,057,855  $4,453,898  $625,801  $1,261,323  $1,155,189  $977,440  $8,473,651  $196,352  $8,670,003 
                                                                
RATE SENSITIVE LIABILITIES:                                                                
Noninterest bearing demand $81,481  $225,594  $483,524  $349,989  $917,298  $2,057,886          $71,984  $199,273  $426,953  $308,870  $866,822  $1,873,902         
Interest bearing transaction  459,455   —   —   —   —   459,455           862,553   —   —   —   —   862,553         
Savings and money market  2,573,258   —   —   —   —   2,573,258           2,712,143   —   —   —   —   2,712,143         
Time deposits  313,425   523,156   411,545   30,282   3,298   1,281,706           255,101   649,747   459,757   133,547   3,142   1,501,294         
Customer repurchase agreements and fed funds purchased  36,446   —   —   —   —   36,446           31,669   —   —   —   —   31,669         
Other borrowings  125,000   200,000   147,930   —   69,268   542,198           225,000   —   148,130   —   69,361   442,491         
Total $3,589,065  $948,750  $1,042,999  $380,271  $989,864  $6,950,949  $45,255  $6,996,204  $4,158,450  $849,020  $1,034,840  $442,417  $939,325  $7,424,052  $61,369  $7,485,421 
GAP $610,172  $(246,873) $161,552  $545,892  $(145,336) $925,407          $295,448  $(223,219) $226,483  $712,772  $38,115  $1,049,599         
Cumulative GAP $610,172  $363,299  $524,851  $1,070,743  $925,407              $295,448  $72,229  $298,712  $1,011,484  $1,049,599             
                                                                
Cumulative gap as percent of total assets  7.57%  4.51%  6.51%  13.29%  11.48%              3.41%  0.83%  3.45%  11.67%  12.11%            
                                                                
OFF BALANCE-SHEET:                                                                
Interest Rate Swaps - LIBOR based $150,000  $—  $(75,000) $(75,000) $—  $—          $100,000  $—  $(100,000) $—  $—  $—         
Interest Rate Swaps - Fed Funds based  100,000   —   (100,000)  —   —   —           —   —   —   —   —   —         
Total $250,000  $—  $(175,000) $(75,000) $—  $—  $—  $—  $100,000  $—  $(100,000) $—  $—  $—  $—  $— 
GAP $860,172  $(246,873) $(13,448) $470,892  $(145,336) $925,407          $395,448  $(223,219) $126,483  $712,772  $38,115  $1,049,599         
Cumulative GAP $860,172  $613,299  $599,851  $1,070,743  $925,407  $—          $395,448  $172,229  $298,712  $1,011,484  $1,049,599  $—         
Cumulative gap as percent of total assets  10.67%  7.61%  7.44%  13.29%  11.48%              4.56%  1.99%  3.45%  11.67%  12.11%            

 

(1) Includes loans held for sale.

(1)Includes loans held for sale
(2)Nonaccrual loans are included in the over 60 months category

(2) Nonaccrual loans are included in the over 60 months category.


Capital Resources and Adequacy

 

The assessment of capital adequacy depends on a number of factors such as asset quality and mix, liquidity, earnings performance, changing competitive conditions and economic forces, stress testing, regulatory measures and policy, as well as the overall level of growth and complexity of the balance sheet. The adequacy of the Company’s current and future capital needs is monitored by management on an ongoing basis. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses.

 

The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development, and other land acquisitions which represent 100% or more of an institution’s total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institution’s total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios, and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans, and the Company has experienced growth in its commercial real estate portfolio in recent years. At SeptemberJune 30, 20182019, non-owner-occupied commercial real estate loans (including construction, land, and land development loans) represent 332%337% of total risk based capital. Construction, land and land development loans represent 116%118% of total risk based capital. Management has extensive experience in commercial real estate lending, and has implemented and continues to maintain heightened risk management procedures, and strong underwriting criteria with respect to its commercial real estate portfolio. Loan monitoring practices include but are not limited to periodic stress testing analysis to evaluate changes to cash flows, owing to interest rate increases and declines in net operating income. Nevertheless, we may be required to maintain higher levels of capital as a result of our commercial real estate concentrations, which could require us to obtain additional capital, and may adversely affect shareholder returns. The Company has an extensive Capital Plan and Policy, which includes pro-forma projections including stress testing within which the Board of Directors has established internal minimum targets for regulatory capital ratios that are in excess of well capitalized ratios.

 


The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors and the regulators can lower classifications in certain cases. Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial statements.

 

The prompt corrective action regulations provide five categories, including well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial condition. If a bank is only adequately capitalized, regulatory approval is required to, among other things, accept, renew or roll-over brokered deposits. If a bank is undercapitalized, capital distributions and growth and expansion are limited, and plans for capital restoration are required.

 

The Board of Governors of the Federal Reserve Board and the FDIC have adopted rules (the “Basel III Rules”) implementing the Basel Committee on Banking Supervision’s capital guidelines for U.S. banks (commonly known as Basel III). Under the Basel III rules, when fully phased in on January 1, 2019, the Company and Bank will beare required to maintain, inclusive of the fully phased in capital conservation buffer of 2.5%, a minimum CET1 ratio of 7.0%; a minimum ratio of Tier 1 capital to risk-weighted assets of 8.5% a minimum total capital to risk-weighted assets ratio of 10.5% and requires a minimum leverage ratio of 4.0%.


The actual capital amounts and ratios for the Company and Bank as of SeptemberJune 30, 20182019 and December 31, 20172018 are presented in the table below.

         

Minimum Required For

Capital Adequacy Purposes

 

To Be Well Capitalized Under Prompt

Corrective Action

Regulations *

 
         
 Minimum Required
For Capital Adequacy
Purposes		 To Be Well Capitalized
Under Prompt
Corrective Action
Regulations *		          
 Company  Bank     Company Bank 
 Actual Actual  Actual Actual 
(dollars in thousands) Amount  Ratio  Amount  Ratio      Amount Ratio Amount Ratio  
As of September 30, 2018             
CET1 capital (to risk weighted assets) $961,904   12.11% $1,099,670   13.86%  6.375%  6.5%
As of June 30, 2019             
CET1 capital (to risk weighted aseets) $1,075,087 12.87% $1,227,269 14.70% 7.000% 6.5%
Total capital (to risk weighted assets)  1,250,148   15.74%  1,167,914   14.72%  9.875%  10.0% 1,367,227 16.36% 1,299,409 15.57% 10.500% 10.0%
Tier 1 capital (to risk weighted assets)  961,904   12.11%  1,099,670   13.86%  7.875%  8.0% 1,075,087 12.87% 1,227,269 14.70% 8.500% 8.0%
Tier 1 capital (to average assets)  961,904   12.13%  1,099,670   13.87%  5.000%  5.0% 1,075,087 12.66% 1,227,269 14.46% 4.000% 5.0%
                                     
As of December 31, 2017                        
As of December 31, 2018             
CET1 capital (to risk weighted aseets) $845,123   11.23% $969,250   12.91%  5.750%  6.5% $1,007,438 12.49% $1,147,151 14.23% 6.375% 6.5%
Total capital (to risk weighted assets)  1,129,954   15.02%  1,033,554   13.76%  9.250%  10.0% 1,297,427 16.08% 1,217,140 15.10% 9.875% 10.0%
Tier 1 capital (to risk weighted assets)  845,123   11.23%  969,250   12.91%  7.250%  8.0% 1,007,438 12.49% 1,147,151 14.23% 7.875% 8.0%
Tier 1 capital (to average assets)  845,123   11.45%  969,250   13.15%  5.000%  5.0% 1,007,438 12.10% 1,147,151 13.78% 5.000% 5.0%

  

* Applies to Bank only

 

Bank and holding company regulations, as well as Maryland law, impose certain restrictions on dividend payments by the Bank, as well as restricting extensions of credit and transfers of assets between the Bank and the Company. At SeptemberJune 30, 20182019 the Bank could pay dividends to the parent to the extent of its earnings so long as it maintained required capital ratios.

 

Use of Non-GAAP Financial Measures

 

The Company considers the following non-GAAP measurements useful for investors, regulators, management and others to evaluate capital adequacy and to compare against other financial institutions. The tables below provide a reconciliation of these non-GAAP financial measures with financial measures defined by GAAP.

 

Tangible common equity to tangible assets (the “tangible common equity ratio”) and tangible book value per common share are non-GAAP financial measures derived from GAAP-based amounts. The Company calculates the tangible common equity ratio by excluding the balance of intangible assets from common shareholders’ equity and dividing by tangible assets. The Company calculates tangible book value per common share by dividing tangible common equity by common shares outstanding, as compared to book value per common share, which the Company calculates by dividing common shareholders’ equity by common shares outstanding. The Company calculates return on average tangible common equity by dividing annualized year to date net income by tangible common equity. The Company considers this information important to shareholders as tangible equity is a measure that is consistent with the calculation of capital for bank regulatory purposes, which excludes intangible assets from the calculation of risk based ratios.


GAAP Reconciliation (Unaudited)

(dollars in thousands except per share data)

 Three Months Ended
September 30, 2018		 Nine Months Ended
September 30, 2018		 Twelve Months Ended
December 31, 2017		 Three Months Ended
September 30, 2017		 Nine Months Ended
September 30, 2017		            
Common shareholders' equity     $1,061,651  $950,438      $933,982 
 Three Months Ended
June 30, 2019		  Six Months Ended
June 30, 2019		  

Twelve Months Ended

December 31, 2018

  

Three Months Ended

June 30, 2018

  

Six Months Ended

June 30, 2018

 
Common shareholders’ equity     $1,184,582  $1,108,941      $1,023,137 
Less: Intangible assets      (106,481)  (107,212)      (107,150)      (105,219)  (105,766)      (106,820)
Tangible common equity     $955,170  $843,226      $826,832      $1,079,363  $1,003,175      $916,317 
                                        
Book value per common share     $30.94  $27.80      $27.33      $34.30  $32.25      $29.82 
Less: Intangible book value per common share      (3.10)  (3.13)      (3.14)      (3.05)  (3.08)      (3.11)
Tangible book value per common share     $27.84  $24.67      $24.19      $31.25  $29.17      $26.71 
                    
Total assets     $8,057,855  $7,479,029      $7,393,656      $8,670,003  $8,389,137      $7,880,017 
Less: Intangible assets      (106,481)  (107,212)      (107,150)      (105,219)  (105,766)      (106,820)
Tangible assets     $7,951,374  $7,371,817      $7,286,506      $8,564,784  $8,283,371      $7,773,197 
Tangible common equity ratio      12.01%  11.44%      11.35%      12.60%  12.11%      11.79%
Average common shareholders' equity $1,040,826  $1,003,439  $906,174  $921,493  $890,817 
                    
Average common shareholders’ equity $1,166,487  $1,147,782  $1,022,642  $1,002,091  $984,436 
Less: Average intangible assets  (106,629)  (106,949)  (107,117)  (107,010)  (107,105)  (105,280)  (105,430)  (106,806)  (106,955)  (107,112)
Average tangible common equity $934,197  $896,490  $799,057  $814,483  $783,712  $1,061,206  $1,042,352  $915,836  $895,136  $877,324 
                                        
Net Income $38,949  $111,959  $100,232  $29,874  $84,663  $37,243  $70,992  $152,276  $37,296  $73,011 
Average tangible common equity $934,197  $896,490  $799,057  $814,483  $783,712  $1,061,206  $1,042,352  $915,836  $895,136  $877,324 
Annualized Return on Average Tangible Common  16.54%  16.70%  12.54%  14.55%  14.44%
Equity                    
Annualized Return on Average Tangible Common Equity  14.08%  13.73%  16.63%  16.71%  16.78%

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk

 

Please refer to Item 2 of this report, “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the caption “Asset/Liability Management and Quantitative and Qualitative Disclosure about Market Risk.”

 

Item 4. Controls and Procedures

Evaluation of disclosure controls and procedures. Based on the evaluation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)) under the Securities Exchange Act of 1934) required by Rules 13a-15(b) or 15d-15(b) under the Securities Exchange Act of 1934, our Chief Executive Officer and our Chief Financial Officer have concluded that the Company maintained effective disclosure controls and procedures as of SeptemberJune 30, 2018.2019.

 

Changes in internal controls. There were no changes in our internal control over financial reporting as defined in Exchange Act Rules 13a-15(f) and 15d-15(f) that occurred during the thirdsecond quarter of 20182019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.


PART II - OTHER INFORMATION

 

Item 1 - Legal Proceedings

 

From time to time the Company and its subsidiaries are participants in various legal proceedings incidental to their business. In the opinion of management, the liabilities (if any) resulting from such legal proceedings will not have a material effect on the financial position of the Company.

On July 24, 2019, a putative class action lawsuit was filed in the United States District Court for the Southern District of  New York against the Company, its current and former President and Chief Executive Officer and its current and former Chief Financial Officer, on behalf of persons similarly situated, who purchased or otherwise acquired Company securities between March 2, 2015 and July 17, 2019. Shiva Stein vs. Eagle Bancorp, Inc., et. al. (Case 1:19-cv-06873).  The plaintiff in the action alleges that certain of the Company’s 10-K reports and other public disclosures contained material misrepresentations, or omitted material information, about the business, operations and management of the Company, including the effectiveness of its internal controls and related party transactions, in violation of Section 10(b) of the Securities Exchange Act of 1934 and Rule 10(b)-5 thereunder and Section 20(a) of that act, resulting in injury to the purported class members as a result the decline in the value of the Company’s common stock following the disclosure of increased legal expenses associated with certain government investigations involving the Company. The relief sought in the lawsuit includes damages. While we continue to review the complaint, the Company believes that the claims asserted are without merit and intends to defend vigorously against them.

 

Item 1A –- Risk Factors

 

There have been no material changes as of SeptemberJune 30, 20182019 in the risk factors from those disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.2018.

 

Item 2 - Unregistered Sales of Equity Securities and Use of Proceeds

 

(a)Sales of Unregistered Securities.None
 
(b)Use of Proceeds.Not Applicable
(c)Issuer Purchases of Securities.None

 

(b)Use of Proceeds.Not Applicable

(c)Issuer Purchases of Securities.None

Item 3 - Defaults Upon Senior SecuritiesNone

 

Item 4 - Mine Safety DisclosuresNot Applicable

 

Item 5 - Other Information

 

(a)Required 8-K DisclosuresNone
 None

(b)Changes in Procedures for Director NominationsNone

  

Item 6 - Exhibits

 

3.1Certificate of Incorporation of the Company, as amended (1)
3.2Bylaws of the Company (2)
4.1Subordinated Indenture, dated as of August 5, 2014, between the Company and Wilmington Trust, National Association, as Trustee  (3)
4.2First Supplemental Indenture, dated as of August 5, 2014, between the Company and Wilmington Trust, National Association, as Trustee (4)
4.3Form of Global Note representing the 5.75% Subordinated Notes due September 1, 2024 (included in Exhibit 4.2)
4.4Second Supplemental Indenture, dated as of July 26, 2016, between the Company and Wilmington Trust, National Association, as Trustee (5)
4.5Form of Global Note representing the 5.00% Fixed-to-Floating Rate Subordinated Notes due August 1, 2026 (included in Exhibit 4.4)
10.12016 Stock Option Plan (6)
10.22006 Stock Plan (7)
10.3Employment Agreement dated as of April 7, 2017, between EagleBank and Charles D. Levingston (8)
10.4Amended and Restated Employment Agreement dated as of January 31, 2017, between EagleBank and Antonio F. Marquez  (9)
10.5Amended and Restated Employment Agreement dated as of January 31, 2017, between Eagle Bancorp, Inc., EagleBank and Ronald D. Paul (10)
10.6Amended and Restated Employment Agreement dated as of January 31, 2017, between EagleBank and Susan G. Riel (11)(10)
10.710.6Amended and Restated Employment Agreement dated as of January 31, 2017, between EagleBank and Janice L. Williams (12)(11)


10.810.7Non-Compete Agreement dated as of April 7, 2017, between EagleBank and Charles D. Levingston (13)(12)
10.910.8Non-Compete Agreement dated as of August 1, 2014, between EagleBank and Antonio F. Marquez (14)(13)

10.10Non-Compete Agreement dated as of August 1, 2014, between EagleBank and Ronald D. Paul (15)
10.1110.9 Non-Compete Agreement dated as of August 1, 2014, between EagleBank and Susan G. Riel (16)(14)
10.1210.10  Non-Compete Agreement dated as of August 1, 2014, between EagleBank and Janice L. Williams (17)(15)
10.1310.11Form of Supplemental Executive Retirement Plan Agreement (18)(16)
10.1410.124Amended and Restated Employment Agreement dated as of January 31, 2017 between EagleBank and Lindsey S. Rheaume (19)(17)
10.1510.13Non-Compete Agreement dated as of December 15, 2014, between EagleBank and Lindsey S. Rheaume (20)(18)
10.1610.14Virginia Heritage Bank 2006 Stock Option Plan (21)(19)

10.17

10.15		Virginia Heritage Bank 2010 Long-Term Incentive Plan (22)(20)
10.18First Amendment to Amended and Restated Employment Agreement of Ronald D. Paul (23)
10.1910.16First Amendment to Employment Agreement of Charles D. Levingston (24)(21)
10.2010.17First Amendment to Amended and Restated Employment Agreement of Antonio F. Marquez (25)(22)
10.2110.18First Amendment to Amended and Restated Employment Agreement of Susan G. Riel (26)(23)
10.2210.19First Amendment to Amended and Restated Employment Agreement of Janice L. Williams (27)(24)
10.2310.20First Amendment to Amended and Restated Employment Agreement of Lindsey S. Rheaume (28)(25)
10.2410.2120182019 Senior Executive Incentive Plan (29)(26)
10.2510.2220182019 Long Term Incentive Plan (30)(27)
11Statement Regarding Computation of Per Share Income
 

See Note 911 of the Notes to Consolidated Financial Statements

21Subsidiaries of the Registrant
31.1Certification of Ronald D. PaulSusan G. Riel
31.2Certification of Charles D. Levingston
32.1Certification of Ronald D. PaulSusan G. Riel
32.2Certification of Charles D. Levingston
101    Interactive data files pursuant to Rule 405 of Regulation S-T:

 (i)Consolidated Balance Sheets at SeptemberJune 30, 2018,2019, December 31, 20172018
 (ii)Consolidated Statement of Operations for the three and ninesix months ended SeptemberJune 30, 20182019 and 20172018
 (iii)Consolidated Statement of Comprehensive Income for the three and ninesix months ended SeptemberJune 30, 20182019 and 20172018
 (iv)Consolidated Statement of Changes in Shareholders’ Equity for the ninethree and six months ended SeptemberJune 30, 20182019 and 20172018
 (v)Consolidated Statement of Cash Flows for the ninesix months ended SeptemberJune 30, 20182019 and 20172018
 (vi)Notes to the Consolidated Financial Statements

 

 

(1)Incorporated by reference to the Exhibit of the same number to the Company’s Current Report on Form 8-K filed on May 17, 2016.
(2)Incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed on December 18, 2017.
(3)Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K filed on August 5, 2014.
(4)Incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K filed on August 5, 2014.
(5)Incorporated by Reference to Exhibit 4.2 to the Company’s Current report on Form 8-K filed on July 22, 2016.
(6)Incorporated by reference to Exhibit 4 to the Company’s Registration Statement on Form S-8 (Registration No. 333-211857) filed on June 6, 2016.
(7)Incorporated by reference to Exhibit 4 to the Company’s Registration Statement on Form S-8 (No. 333-187713)
(8)Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on April 11, 2017.


(9)Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on February 6, 2017.
(10)Incorporated by reference to Exhibit 10.310.4 to the Company’s Current Report on Form 8-K filed on February 6, 2017.
(11)Incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed on February 6, 2017.
(12)Incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed on February 6, 2017.

(13)(12)Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on April 11, 2017.
(14)(13)Incorporated by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K filed on December 15, 2014.
(15)Incorporated by reference to Exhibit 10.8 to the Company’s Current Report on Form 8-K filed on December 15, 2014.
(16)(14)Incorporated by reference to Exhibit 10.9 to the Company’s Current Report on Form 8-K filed on December 15, 2014.
(17)(15)Incorporated by reference to Exhibit 10.10 to the Company’s Current Report on Form 8-K filed on December 15, 2014.
(18)(16)Incorporated by reference to Exhibit 10.22 to the Company’s Annual Report on Form 10-K for the Year ended December 31, 2013.
(19)(17)Incorporated by reference to Exhibit 10.7 to the Company’s current Report on Form 8-K filed on February 6, 2017.
(20)(18)Incorporated by reference to Exhibit 10.29 to the Company’s Form 10-Q for the Quarter ended March 31, 2015.
(21)(19)Incorporated by reference to Exhibit 4.1 to the Company’s Registration Statement on Form S-8 (No. 333-199875)
(22)(20)Incorporated by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-8 (No. 333-199875)
(21)Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on February 28, 2018.
(22)Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on February 28, 2018.
(23)Incorporated by reference to Exhibit 10.110.4 to the Company’s Current Report on Form 8-K filed on February 28, 2018.
(24)Incorporated by reference to Exhibit 10.210.5 to the Company’s Current Report on Form 8-K filed on February 28, 2018.
(25)Incorporated by reference to Exhibit 10.310.7 to the Company’s Current Report on Form 8-K filed on February 28, 2018.
(26)Incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed on February 28, 2018.
(27)Incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed on February 28, 2018.
(28)Incorporated by reference to Exhibit 10.7 to the Company’s Current Report on Form 8-K filed on February 28, 2018.
(29)Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on February 16, 2018.15, 2019.
(30)(27)Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 16, 2018.15, 2019.

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 EAGLE BANCORP, INC.
  
Date: NovemberAugust 9, 20182019By:/s/ Ronald D. PaulSusan G. Riel
  Ronald D. Paul, Chairman,Susan G. Riel, President and Chief Executive Officer of the Company
   
Date: NovemberAugust 9, 20182019By:/s/ Charles D. Levingston
  Charles D. Levingston, Executive Vice President and
Chief Financial Officer of the Company

 

69 66